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The capital asset pricing model

The capital asset pricing model is derived from modern portfolio theory and is an equity valuation model that challenges analysts and business professionals alike. One of the first practical uses of the model was in determining the cost of equity for public utilities. Public utility commissions use the estimated cost of equity to set allowable rates that utilities can charge consumers; as a result, the underlying model has far-reaching effects in the economy. The capital assets pricing model (CAPM) has come under some criticism regarding the assumptions on which it is based, tests that cannot prove that it describes what has actually occurred, and the difficulty in arriving at the best estimates for input to the model. This research provides a critical examination of the capital assets pricing model.

At the heart of any pricing model is the challenge of measuring value. This problem is applicable to the price of a company's stock, the value of a potential acquisition, or any other asset that may require valuation. The term "value" is generally given to mean the fair price that an investor would be willing to pay for a firm, a portion of a firm, or any other asset, and it is determined by three factors: the size of the anticipated return, the date that these returns will be received, and the risk that the investor takes to obtain the returns (Lewellen & Ang, 1982, p. 113).

Of these three factors, risk is generally the most difficult to measure and to incorporate into a valuation. Regardless of whether the valuation in question is of practical or theoretical interest, risk is difficult to measure, and even controversial in its own definition.

A number of valuation methods have been developed and tested since the mid-1960s. The difference between these techniques and those that precede them is the perspective that the new techniques take. Older models evaluated each stock, bond, or company singly and considered the asse...

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The capital asset pricing model. (1969, December 31). In LotsofEssays.com. Retrieved 12:25, March 28, 2024, from https://www.lotsofessays.com/viewpaper/1700637.html