The Capital Asset Pricing Model (CAPM) operates on the principle that asset returns are linearly explained solely by market beta under conditions of rational agents with homogeneous expectations, forming a cornerstone of modern portfolio theory within financial economics. However, empirical analysis demonstrates that these simplifying assumptions—specifically regarding risk-free borrowing and complete investor agreement—are domain-specific rather than negligibility assumptions, leading to significant theoretical invalidity when applied to real-world markets characterized by outliers and non-linear return distributions such as book-to-market anomalies. Consequently, the CAPM is fundamentally limited as a predictive tool because its core axioms do not align with observed market data where alternative variables like value factors provide superior explanatory power over beta premiums.
The Capital Asset Pricing Model (CAPM) operates on the principle that asset returns are linearly explained solely by market beta under conditions of rational agents with homogeneous expectations, for…