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The Capital Asset Pricing Model: Theory and Evidence


Eugene F. Fama


University of Chicago - Finance

Kenneth R. French


Dartmouth College - Tuck School of Business; National Bureau of Economic Research (NBER)

August 2003

CRSP Working Paper No. 550; Tuck Business School Working Paper No. 03-26

Abstract:     
The capital asset pricing model (CAPM) of William Sharpe (1964) and John Lintner (1965) marks the birth of asset pricing theory (resulting in a Nobel Prize for Sharpe in 1990). Before their breakthrough, there were no asset pricing models built from first principles about the nature of tastes and investment opportunities and with clear testable predictions about risk and return. Four decades later, the CAPM is still widely used in applications, such as estimating the cost of equity capital for firms and evaluating the performance of managed portfolios. And it is the centerpiece, indeed often the only asset pricing model taught in MBA level investment courses.

The attraction of the CAPM is its powerfully simple logic and intuitively pleasing predictions about how to measure risk and about the relation between expected return and risk. Unfortunately, perhaps because of its simplicity, the empirical record of the model is poor - poor enough to invalidate the way it is used in applications. The model's empirical problems may reflect true failings. (It is, after all, just a model.) But they may also be due to shortcomings of the empirical tests, most notably, poor proxies for the market portfolio of invested wealth, which plays a central role in the model's predictions. We argue, however, that if the market proxy problem invalidates tests of the model, it also invalidates most applications, which typically borrow the market proxies used in empirical tests.

For perspective on the CAPM's predictions about risk and expected return, we begin with a brief summary of its logic. We then review the history of empirical work on the model and what it says about shortcomings of the CAPM that pose challenges to be explained by more complicated models.

Number of Pages in PDF File: 35

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Date posted: September 16, 2003  

Suggested Citation

Fama, Eugene F. and French, Kenneth R., The Capital Asset Pricing Model: Theory and Evidence (August 2003). CRSP Working Paper No. 550; Tuck Business School Working Paper No. 03-26. Available at SSRN: http://ssrn.com/abstract=440920 or http://dx.doi.org/10.2139/ssrn.440920

Contact Information

Eugene F. Fama
University of Chicago - Finance ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-7282 (Phone)
773-702-9937 (Fax)
Kenneth R. French (Contact Author)
Dartmouth College - Tuck School of Business ( email )
Hanover, NH 03755
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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