The Failure of the Capital Asset Pricing Model (CAPM): An Update and Discussion

Abstract

Dempsey (2013) argues that, contrary to the generally held view, the capital asset pricing model (CAPM) has never merited an empirical justification. Additionally, he considers that if investors care about their exposure to the markets (requiring an equity risk premium) but are apparently indifferent to how that exposure is encapsulated in any stock (the measure of which is beta), then it is difficult to see how investors can be sensitive to the risk factors in the Fama and French (1996) threefactor model as actual 'risk' factors. Consequently, he doubts the value of much of the asset pricing literature aimed at refining the models.The CAPM faces three main empirical challenges: (a) The beta anomaly (portfolios of low beta stocks tend to have higher average returns than the CAPM predicts while portfolios of high beta stocks tend to have lower average returns than the CAPM predicts); (b) the value anomaly (firms with high book-to-market equity [BE/ME] ratios tend to have higher average returns than do firms with low bookto-market ratios); and (c) the momentum anomaly (stocks with relatively large recent six-month to 12-month returns tend to have higher average returns over the following 12 months than do stocks with relatively low recent six-month to 12-month returns). Recent evidence of the beta and value anomalies can be found in Fama and French (2006) while Jegadeesh and Titman (2001) update the U.S. evidence for the momentum anomaly.This paper contributes to the existing literature by showing: (a) that the CAPM fails empirically when applied to industries (previous studies looked mostly at the adequacy of the CAPM when applied to stocks); (b) that after 1993 the value and momentum anomalies appear to continue whereas the beta anomaly appears to have weakened; and (c) that the value and momentum anomalies, and the value of beta, can largely be ignored if the task is to estimate industry cost of equity. 1 DATA AND METHODOLOGYTo update the evidence about the beta, value and momentum anomalies, the returns of 48 U.S. industries are investigated. Data for the period

Estimating the Cost of Equity Capital: An Empirical Analysis in the Tunisian Context

“…These results are also corroborated by Fama and French (1996) and Jegadeesh and Titman (2001) in the US and other markets like the Asian ones (Rouwenhorst, 1998;Chui, Wei, & Titman, 2000) and emerging markets (Rouwenhorst, 1999). In the United States, Hammami (2013) shows that the momentum effect exists only for periods characterized by low market premium (good times), while Bornholt (2013) shows that the anomaly disappears when working on sectoral costs of equity capital.…”

Nexuses between Economic Factors and Stock Returns in China

“…The positive association, on the other hand, is suggested by the Keynesian approach since there exists positive relationship are present between economic activity and price level and therefore there must be a positive association between activity and the stock returns. Bornholt (2013) expanded on the popular CAPM and developed an equilibrium asset pricing model in which positive inflation rate and low earnings systems are connected with increase in overall stock return. The two studies by Dempsey (2013) and Bornholt (2013) demonstrated the inconclusiveness of different study outcomes and methodologies on the nexus between stock returns and economic fundamentals.…”

The CAPM: A Case of Elegance is for Tailors?

“…Tellingly, Bornholt () in his response extends their analysis to end‐2009 (confirming the general non‐applicability of the CAPM, but noting nonetheless that the beta anomaly has weakened in more recent times). Bornholt considers that as the continued existence of non‐compliance with the CAPM offers investing opportunities (invest in low beta assets and avoid high betas), the market must eventually learn to comply with the CAPM.…”