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Lessons Learned from Attacking CAPM

| | Posted in: Volatility Effects

How diverse are the beliefs of experts on the Capital Asset Pricing Model (CAPM)? In his November paper entitled “CAPM: The Model and 233 Comments about It”, Pablo Fernandez reproduces 52 largely disagreeing and 181 largely agreeing comments solicited from professors, finance professionals and Ph.D. students regarding his prior paper entitled “CAPM: an Absurd Model” (summarized in “Forget CAPM Beta?”). The range of beliefs in the comments is extreme, from

“I was shocked at how horrible your paper is. It is without a doubt the worst excuse for an academic study I have ever seen (and believe me that is saying a lot).”


“I totally agree with the absurdity of CAPM model.”

After reflecting on the body of comments, he concludes that:

  • CAPM does not find “more risk, more return” but rather “more beta, more expected return.”
  • CAPM is absurd not only because of its assumptions, but also because of the failures of its predictions.
  • One could talk of the expected return for a publicly traded asset if investors have the same expectations, but investors do not have the same expectations.
  • The CAPM and factor models are not comparable:
    • CAPM is an absurd model built on obviously incorrect assumptions.
    • Factor models are empirical, requiring no fundamental assumptions.
  • A common request of many students and investment managers is: “Give me a rule of thumb I can follow without thinking.”

In summary, reported comments indicate that beliefs within the finance community regarding a well-known and widely used model are are extremely diverse and sometimes expressed in “animal spirits” mode.

Such diversity of beliefs among finance community experts may well hold for other finance models and hypotheses.

Cautions regarding conclusions include:

  • Comments are not segmented by professor, finance professional and Ph.D. student categories.
  • The comment solicitation process may produce a sample not representative of the finance community.
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