Criticism on Capital Asset Pricing Model
It is pertinent to mention here that the CAPM theory is about the real world; but it does not describe the real world fully.
Richard Roll, in the Journal of Financial Economics, argued that, because it is almost impractical to develop a portfolio that includes every single security (called a true market portfolio), any test of the CAPM that uses a market proxy (e.g. FTSE 100, DAX, CAC 40) will be testing that specific portfolio, and not the “true market portfolio”.
Capital Asset Pricing Model is empirically un-testable because the market portfolio on which it is based is unobservable.
Whenever we implement CAPM test that use market proxies, we will have to face this criticism.
• CAPM is used for single-period though it can be used for multi-period but the assumptions on which it is based decrease the reliance upon that model
• CAPM does not account for transaction costs.
• Betas used in this model based on large number of observations but all related to the past, hence not reliable fully for making future investment decisions.
• It is often quite difficult to find the (rm – rf) or even the rf which is itself probable to be differ for macroeconomic reasons.
• CAP Model depends on an efficient investment market and if this market exhibits imperfections, this would not help the investors to eliminate specific risk from their portfolios.
• Despite all critics, CAMP is getting popularity among investors all over the world due to its positive aspects of its workings. So it is considered as a useful tool by the investors for having it in their investment appraisal kit.