Capital Asset Pricing Model (CAPM) Testability and its Validity in Stock Market: Evidence from Previous Literatures

Abstract

Stocks such as bonds, treasurers and common stocks have been used in many companies to raise capital and improve investment for the benefit of the company or individual. Many companies has been raising or buying stocks for the investment benefit. Manager’s decisions about stock pricing, stocks rising, stocks purchasing, investment valuation, etc have depended on market situation of such period in particular. As we know that managers or individuals cannot expect to succeed without understand how market forces shape the firm’s ability to earn profit. Therefore, risk and return which associated with stocks have been given attention with companies and individuals, which was the cause of establishment of many models for these evaluations. One of the modal is Capital Asset Pricing Model(CAPM) which has became useful for assessment of cost of capital, portfolio performance, and portfolio diversification, valuing investments, choosing portfolio strategy among others and relationship between risk and return in market portfolio. The aim of this paper is to identify the validity of CAPM by thoroughly reviewing the literature and seeing whether its assumptions which used to guide its usage are holding true. Methodology used; CAPM is discussed under four categories which are the CAPM as a single factor model, supportive evidence of the CAPM evidence against it through various literatures. Findings showed that the CAPM remains a very useful item in the investment management toolkit. And investors trust it to evaluate the profitability of projects.

Keywords: Risk, Return, Portfolio, Asset, Validity, market, CAPM’