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The CAPM debate

Author

Listed:
  • Ravi Jagannathan
  • Ellen R. McGrattan

Abstract

This article describes the academic debate about the usefulness of the capital asset pricing model (the CAPM) developed by Sharpe and Lintner. First the article describes the data the model is meant to explain?the historical average returns for various types of assets over long time periods. Then the article develops a version of the CAPM and describes how it measures the risk of investing in particular assets. Finally the article describes the results of competing studies of the model's validity. Included are studies that support the CAPM (Black; Black, Jensen, and Scholes; Fama and MacBeth), studies that challenge it (Banz; Fama and French), and studies that challenge those challenges (Amihud, Christensen, and Mendelson; Black; Breen and Korajczyk; Jagannathan and Wang; Kothari, Shanken, and Sloan). The article concludes by suggesting that, while academic debate continues, the CAPM may still be useful for those interested in the long run.

Suggested Citation

  • Ravi Jagannathan & Ellen R. McGrattan, 1995. "The CAPM debate," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 19(Fall), pages 2-17.
    • Handle: RePEc:fip:fedmqr:y:1995:i:fall:p:2-17:n:v.19no.4
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    References listed on IDEAS

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    1. Fama, Eugene F & French, Kenneth R, 1992. "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    2. Stambaugh, Robert F., 1982. "On the exclusion of assets from tests of the two-parameter model : A sensitivity analysis," Journal of Financial Economics, Elsevier, vol. 10(3), pages 237-268, November.
    3. Shanken, Jay, 1985. "Multivariate tests of the zero-beta CAPM," Journal of Financial Economics, Elsevier, vol. 14(3), pages 327-348, September.
    4. Ravi Jagannathan & Zhenyu Wang, 1993. "The CAPM is alive and well," Staff Report 165, Federal Reserve Bank of Minneapolis.
    5. Banz, Rolf W., 1981. "The relationship between return and market value of common stocks," Journal of Financial Economics, Elsevier, vol. 9(1), pages 3-18, March.
    6. V. V. Chari & Ravi Jagannathan & Aharon R. Ofer, 1987. "Seasonalities in security returns: the case of earnings announcements," Staff Report 110, Federal Reserve Bank of Minneapolis.
    7. Kothari, S P & Shanken, Jay & Sloan, Richard G, 1995. "Another Look at the Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 50(1), pages 185-224, March.
    8. Ferson, Wayne E & Korajczyk, Robert A, 1995. "Do Arbitrage Pricing Models Explain the Predictability of Stock Returns?," The Journal of Business, University of Chicago Press, vol. 68(3), pages 309-349, July.
    9. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    10. Gibbons, Michael R., 1982. "Multivariate tests of financial models : A new approach," Journal of Financial Economics, Elsevier, vol. 10(1), pages 3-27, March.
    11. MacKinlay, A Craig & Richardson, Matthew P, 1991. "Using Generalized Method of Moments to Test Mean-Variance Efficiency," Journal of Finance, American Finance Association, vol. 46(2), pages 511-527, June.
    12. Harvey, Campbell R., 1989. "Time-varying conditional covariances in tests of asset pricing models," Journal of Financial Economics, Elsevier, vol. 24(2), pages 289-317.
    13. Black, Fischer, 1972. "Capital Market Equilibrium with Restricted Borrowing," The Journal of Business, University of Chicago Press, vol. 45(3), pages 444-455, July.
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    Cited by:

    1. Syed ali, Raza & Syed tehseen, jawaid & Imtiaz, arif & Fahim, qazi, 2011. "Validity of capital asset pricing model: evidence from Karachi stock exchange," MPRA Paper 32737, University Library of Munich, Germany.
    2. Surajit Ray & B. Ravikumar & N. Eugene Savin, 1998. "Robust Wald Tests in SUR Systems with Adding Up Restrictions: An Algebraic Approach to Proofs of Invariance," Econometrics 9802002, University Library of Munich, Germany.
    3. Pereiro, Luis E., 2001. "The valuation of closely-held companies in Latin America," Emerging Markets Review, Elsevier, vol. 2(4), pages 330-370, December.
    4. Elizabeth Laderman & Wayne Passmore, 1998. "Is mortgage lending by savings associations special?," Economic Review, Federal Reserve Bank of San Francisco, pages 30-46.
    5. Marrero, Gustavo A. & Puch, Luis A. & Ramos-Real, Francisco J., 2015. "Mean-variance portfolio methods for energy policy risk management," International Review of Economics & Finance, Elsevier, vol. 40(C), pages 246-264.
    6. Patricio Arrau & Rómulo Chumacero, 1998. "Tamaño de los Fondos de Pensiones en Chile y su Desempeño Financiero," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 35(105), pages 205-236.
    7. Hwang, Soosung & Pedersen, Christian S., 2004. "Asymmetric risk measures when modelling emerging markets equities: evidence for regional and timing effects," Emerging Markets Review, Elsevier, vol. 5(1), pages 109-128, March.
    8. Maxfield, Sylvia, 1998. "Understanding the Political Implications of Financial Internationalization in Emerging Market Countries," World Development, Elsevier, vol. 26(7), pages 1201-1219, July.
    9. Ravikumar, B. & Ray, Surajit & Savin, N.E., 1999. "CAPM Reconsidered: A Robust Finite Sample Evaluation," Working Papers 99-04, University of Iowa, Department of Economics.
    10. Dusan Isakov, 1999. "Is beta still alive? Conclusive evidence from the Swiss stock market," The European Journal of Finance, Taylor & Francis Journals, vol. 5(3), pages 202-212.
    11. Galagedera, Don U.A. & Brooks, Robert D., 2007. "Is co-skewness a better measure of risk in the downside than downside beta?: Evidence in emerging market data," Journal of Multinational Financial Management, Elsevier, vol. 17(3), pages 214-230, July.
    12. Kim, Jeong-Ryeol, 2002. "The stable long-run CAPM and the cross-section of expected returns," Discussion Paper Series 1: Economic Studies 2002,05, Deutsche Bundesbank.

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    Keywords

    capital asset pricing model;

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