Monetary policies wedge between economics and markets. (Just what I would do.)
Are risk and reward as correlated as CAPM theory makes it out to be?
A good paper is why CAPM is so ridiculous to use. I mean, jesus, these are the CAPM assumptions.
1. Investors are rational and risk averse. They pursue the only interest of maximizing the expected utility of their end of period wealth. Implication: The model includes the single time horizon for all investors.
2. The markets are perfect, thus taxes, inflation, transaction costs, and short selling restrictions are not taken into account.
3. Investors can borrow and lend unlimited amounts at the risk-free rate (erf ).
4. All assets are infinitely divisible and perfectly liquid.
5. Investors have homogenous expectations about asset returns. In other words, all investors agree about mean and variance as the only system of market assessment, thus everyone perceives identical opportunity. The information is costless, and all investors receive the same information simultaneously.
6. Asset returns conform to the normal distribution.
7. The markets are in equilibrium, and no individual can affect the price of a security.
8. The total number of assets on the market and their quantities are fixed within the defined time frame.
While the CAPM emerges as the most commonly used approach for both institutional and private investors, somebody has to prove that this simple model really holds true in the market.
Every single one of these assumptions are just wrong. An even better paper, if you can get away with it, is why academia doesn't prepare finance students for the actual world because of time spent on ridiculous topics like CAPM and EMH.
This post was edited on 4/23 at 9:10 am