Testing the Waters: Evaluating the Validity of the Capital Asset Pricing Model in India’s Dynamic Market

The Capital Asset Pricing Model (CAPM) is a fundamental framework in financial theory, linking expected asset returns with systematic risk, measured by beta. This study examines the validity of the CAPM in the Indian financial market, which is characterized by unique dynamics distinct from those of developed economies. While the CAPM theoretically supports a linear relationship between risk and return, empirical evidence reveals significant deviations in the Indian context. Using historical stock data from 2019 to 2024 for NIFTY-listed firms, this study examines the predictive power of beta against actual returns through regression analysis and alpha calculations. The findings indicate a weak statistical relationship between beta and returns, with an R² value of 0.003, highlighting the limited explanatory power of the CAPM. Contrary to CAPM predictions, high-beta stocks often underperform, while low-beta stocks occasionally deliver positive alphas. This suggests inefficiencies in the Indian market, driven by behavioral biases, low financial literacy, and varying levels of market integration. The analysis highlights the limitations of the CAPM in capturing the intricacies of India’s financial market and recommends incorporating alternative models, such as the Fama-French three-factor model or behavioral finance approaches. These frameworks could better account for factors such as size, value, and psychological influences on investor decisions. The study recommends further research to adapt the CAPM for emerging markets, thereby aiding investors and policymakers in optimizing strategies within complex economic landscapes.