The CAPM Model: Parameter Estimation and Evaluation of Real-World Applicability

Anders Gry Larsen & Stefan Falck

Student thesis: Master thesis

Abstract

The Capital Asset Pricing Model (CAPM) and its parameters are modeled under central quantitative financial theory applied on recent U.S. data. The fundamental assumptions are econometrically tested, suggesting existence of abnormal returns in violation of theoretical economic properties. The risk-free rate estimation approaches are evaluated and results show significance method-based variance, recommending implementation of a time-variable solution. Beta estimations imply bias from non-systemic fluctuations in extension to time-bias resulting from time-varying estimation. Based on the analyses betas vary significantly from realized values, even under optimal conditions. Estimations of betas and market risk premia are subject to errors in variables, constituting a significant concern for application of market proxies. While implementing time-varying variables increase the robustness of the model in general, its real-world applicability remains limited and must be carried out with caution based on recent data.

EducationsMSc in Finance and Investments, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2017
Number of pages126