A New Perspective on the Validity of the CAPM: Still Alive and Well

Journal of Investment Management (JOIM), Third Quarter 2012

Posted: 13 Oct 2012

See all articles by Moshe Levy

Moshe Levy

Hebrew University of Jerusalem - Jerusalem School of Business Administration

Richard Roll

California Institute of Technology

Date Written: October 12, 2012

Abstract

The Capital Asset Pricing Model (CAPM) has far-reaching practical implications for both investors and corporate managers. The model implies that the market portfolio is mean variance efficient, and thus advocates passive investment. It also provides the most widely used measure of risk, beta, which is used to calculate the cost of capital and excess return (alpha). Most academic studies empirically reject the CAPM, leaving the lack of a better alternative as the only uneasy justification for using the model. Here we take a reverse-engineering approach for testing the model and show that with slight variations in the empirically estimated parameters, well within their estimation-error bounds, the CAPM perfectly holds. Thus, in contrast to the widely held belief, the CAPM cannot be empirically rejected.

Keywords: Mean variance efficiency, CAPM, portfolio optimization, beta

JEL Classification: G00

Suggested Citation

Levy, Moshe and Roll, Richard W., A New Perspective on the Validity of the CAPM: Still Alive and Well (October 12, 2012). Journal of Investment Management (JOIM), Third Quarter 2012, Available at SSRN: https://ssrn.com/abstract=2161087

Moshe Levy (Contact Author)

Hebrew University of Jerusalem - Jerusalem School of Business Administration ( email )

Mount Scopus
Jerusalem, 91905
Israel

Richard W. Roll

California Institute of Technology ( email )

1200 East California Blvd
Mail Code: 228-77
Pasadena, CA 91125
United States
626-395-3890 (Phone)
310-836-3532 (Fax)

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