Create a 8 pages page paper that discusses the relative merits of the capital asset pricing model. The specific fact has been also used as a justification for doubting this model’s value. the model of asset pricing developed by Fama and French is among those theories that most oppose CAPM. The conflict developed between CAPM and other theories of this type has helped not only to identify the weaknesses of CAPM but also to understand its potentials under severe market pressures. Moreover, the research made on CAPM has revealed its ability to be transformed being aligned with the market conditions – a potential that does not exist in traditional theoretical models, which are based on common market conditions.
The Capital Asset Pricing Model (CAPM) is used in order ‘to calculate the required rate of return of an investment’ (Pahl, 2009, p.18). CAPM is the result of the work of the following theorists: W. Sharpe, J. Mossing and J. Lintner (Pahl, 2009, p.18). CAPM is mainly based on the following strategy: the portfolio diversification. through this strategy, the risk for high losses in regard to a particular investment is decreased: investment is distributed among the portfolio of different investment characteristics. in this way, the risk for investors is reduced. CAPM has been developed for helping the investors to identify the level of risk of their investment – based on the fact that the main scope of investment is to result in profits for the amount invested (Pahl, 2009, p.18).
In accordance to Fabozzi et al. (2006, p.209) CAPM is based on a series of assumptions, which can be indicatively described as follows: a) the investment decisions are influenced by the level of the return expected. this means that each investment decision is expected to result to a profit which is estimated in advance, b) investors accept the diversification of their portfolio. this diversification is based on the relevant methodology developed by Markowitz, c) the investment.