Examining Assumptions And Empirical Testing

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According to early academic researches, CAPM seems to have some problems when examining assumptions and empirical testing. Researchers attempt to develop a new model by improving the weak points and make it more realistic which enable investors understand more about financial market situation. Bodie et al. (2014) state that multifactor model could provide better explanation of security returns. Merton (1973) develop ‘Intertemporal model’ to imply that by using beta as a risk measure alone might not yields efficient results in the real world. Therefore, he suggests that other factors could be involved in the calculation. It is clear that he suggests investors to consider not only market risk but also extra market source of risk. Moreover, he mentions that CAPM has a limitations on the economic way of thinking because there are two important factors which are income and many consumption of goods are not be considered. These two factors are changing over time and relative to price. Another significant study of multifactor models is suggested by Fama and French (1992). They explore the validity of CAPM by using beta, size or market value of equity, and book to market equity, price earning and leverage as an explanatory variables. The joint roles of these variables are explored average security’s returns by using cross section analysis. The main results of this study is that variation in returns might not be explained by beta because there is little explanation about mean
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