Limitation of Capm

Assumptions of the Capital Asset Pricing Model  Note! The Capital Asset Pricing Model is a ceteris paribus model. It is only valid within a special set of assumptions. These are: y

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Investors are risk averse individuals who maximize the expected utility of their end of   period wealth. Implication: The model is a o ne period model. Investors have homogenous expectations expectat ions (beliefs) about asset returns. Implication: all investors perceive identical opportunity sets. This means ever yone has the same information at the same time. Asset returns are distributed by the normal distribution. There exists a risk free asset and investors may borrow or lend unlimited amounts of this asset at a constant rate: the risk free rate. There is a definite number o f assets and their quantities are fixated within the one per iod world. All assets are perfectly divisible and priced in a perfectly competitive marked. Implication: e.g. human capital is non-existing ( it is not divisible and it can't be owned as an asset). Asset markets are frictionless and information is costless and simultaneously available to all investors. Implication: borrowing rate equals the lending rate. There are no market imperfections such as taxes, regulations, or restrictions on short selling.

 Normally, all of the assumptions mentioned above are neither valid nor fulfilled. However, CAPM anyway remains one of the most used investments models to determine risk and return.