Is the Capital Asset Pricing Model (CAPM), which relates the return of an asset to its non-diversifiable risk, called beta, worth learning? In his June 2017 paper (provocatively) entitled “Is It Ethical to Teach That Beta and CAPM Explain Something?”, Pablo Fernandez tackles this question. Based on the body of relevant research, he concludes that:
- Many studies demonstrate that CAPM does not fit reality (see “Unreliability of Beta”, “Forget CAPM Beta?” and “Stock Beta Meaningless?”). It is unethical to teach otherwise.
- Users of the CAPM have made many errors valuing companies, accepting/rejecting investments
and evaluating fund performance. - Skepticism should extend to other financial betas and smart beta strategies.
- Investors should instead strive to: (1) analyze and diagnose concrete situations with common sense; (2) make logical decisions; and, (3) challenge assumed “truths.”
In summary, the body of evidence suggests that CAPM beta has such little utility for predicting asset behavior that investors should not use it.
The author tells his students “that although many people use CAPM, it does not explain anything and that it is absurd.”
See also the closely related “Lessons Learned from Attacking CAPM”.
