Growth and Development of the Capital Asset Pricing Model

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Comparing and Contrasting Pricing Model
In this paper I will discuss the growth and development of the Capital Asset pricing Model (CAPM).I will also identify and analyze the different applications to the CAPM. I will try and illustrate how the model can be used to form expected return and valuation measures. These illustrations will be informed by examples from stock options and restricted stock. Finally I will conduct a comparative analysis of the potential outcomes associated and comparative benefits and risks for using the CAPM versus the Arbitrage pricing theory (APT).
Evaluating the development of the Capital Asset pricing Model (CAPM)
How should the risk of an investment, affect its expected return (Perold, 2004)? According to Perold (2004) the Capital Asset Pricing Model (CAPM) was the first coherent framework developed by Sharpe, Lintner and Mossin in 1964, 1965 and 1966 respectively, to answer this question. CAPM fundamental premise is that not every risk should affect an asset’s price, specifically risks that can be diversified away when held alongside other investments in a portfolio, cease to be risks at all (Perold, 2004).
The original CAPM was engineered in a imaginary space, where the following assumptions about investors and the opportunity set were made (Shih, Chen, Lee & Chen, 2014).First, risk-averse investors will maximize the expected return of their wealth(Shih et al,2014).Secondly, price-taking investors have homogenous expectations about joint normally distributed asset returns (Shih et al., 2014).Third, there exists an unlimited amounts of risk-free assets that investors can lend and borrow at a risk-free rate (Shih et al., 2014).Fourth, there are a fixed amount of evenly divisible and marketable assets(S...

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Perold, A.F. (2004).The capital asset model. Journal of Economic Perspectives,18(3),3-24.Retrieved from http://www-personal.umich.edu/~kathrynd/JEP.Perold.pdf
Roll, R. & Ross, S.A.(1980).An empirical investigation of arbitrage pricing theory. Journal of Finance, 35(5), 1073-1103.
Shanken, J. (1982).The arbitrage pricing theory: Is it testable. Journal of Finance,37(5), 1129-1140
Shih, Y., Chen, S., Lee, C., & Chen, P. (2014). The evolution of capital asset pricing models. Review of Quantitative Finance & Accounting, 42(3), 415-448. doi:10.1007/s11156-013-0348-x
Tabak, D. (2002).A CAPM-Based approach to calculating illiquidity discount. NERA Economic Consulting Retrieved from http://www.nera.com/extImage/5657.pdf
Wei, K.(1988).An asset-pricing theory unifying the CAPM and APT. Journal of Finance, 43(4), 881

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