CAPM Failure in Private Equity Valuation and the Alternative APT Method
20 Pages Posted: 12 Mar 2018
Date Written: March 8, 2018
The existing criticisms of CAPM in the financial economics literature in combination with the lack of new generalized risk pricing theories and methods in the private capital markets (PCM) valuation literature suggests there would likely be benefit from the introduction alternative asset pricing theories to the PCM valuation literature. In this connection, this article presents a simple test of CAPM using two publicly-traded securities suggesting that, while certain CAPM concepts are relevant and useful in asset pricing, CAPM theory and related methods are generally inadequate in PCM valuation practice. Again using publicly-traded securities, a method derived from arbitrage pricing theory (APT) is then presented to estimate the no-arbitrage required rate of return for one of the publicly-traded securities. Finally, the method is generalized to a hypothetical PCM valuation setting. The APT-based method presented in the article addresses the most problematic aspects of CAPM theory while providing a generalized risk pricing theory and method for use in PCM valuation practice.
Keywords: CAPM, no-arbitrage asset pricing, private capital markets, valuation
JEL Classification: G11, G12, G32
Suggested Citation: Suggested Citation