Predict the Ruture Returns of Shares. CAPM vs Multifactor Approach

The Capital Asset Pricing Model is a milestone of the forecasting process of the company’s returns by allowing investors to make a prediction of the returns of their investments. However, this model is based on several assumptions that are deemed to be unrealistic, such as the true market portfolio which is impossible to observe in the financial market, and for this reason financial researchers have tried to find other methods with the purpose to overcome the limits of the Capital Asset Pricing Model. Nowadays the alternatives are the Arbitrage Pricing Theory and the Multifactor Approach. The first one affirms that it is possible to predict the expected returns of a securities by analysing the responsiveness to disparate macro-economic factors. The latter allows to consider other factors which can affect the returns’ trend such as the size of the firms, the earnings – price ratio (E/P), the book to market equity ratio (BE/ME) or the cash flow – price ratio (C/P). The main advantage of the Multifactor Approach is that the market portfolio or index is not considered the main source of information, but other accounting features can be introduced in the forecast process of the returns. Nevertheless, it seems impossible to say which is the best models that can explain in a proper way the stocks’ returns.