Is the CAPM a valid model for small investors?

Résumé du document

The CAPM is one of the most famous theories of finance. It was developed by William Sharpe in 1964 with the help of others known researchers. This theory is based on the relationship between risk and return and permits us to calculate an expected return of an investment with few variables. Several tests have been run on the CAPM in order to validate or invalidate the formulae. Through the years, several difference conclusions were found and others factors have been added to the formula in order to be as accurate as possible. However, the CAPM still has arguments both for and against itself. This research has been run for a little investor, who only wants to invest in a small portfolio and for a short period of time. The aim of the study is to see if the CAPM is relevant for this type of investment. After the regression has been made to calculate the Beta and the Alpha, needed to calculate the expected return with the Single Index Model, the applied version of CAPM, the results were not so far away from the annual return. This proves that the CAPM can be a good tool to evaluate the future return of an investment, but it is necessary to use it with cautions.

Extraits

[...] It is the suppliers for the most famous brand of the world. The company made a lot of change in culture and in attitude to become what Rexam today is. For this year, the results are very encouraging regarding to 2002: the operating profit is a little bit less but the profit before tax is worth whereas in 2002 it was worth £-87M. The dividends distributed grow up by and is worth 16,4p per share. Prudential Prudential is a financial company, which offers a large range of service like life insurance, mutual funds, real estate and retirement services. [...]

[...] Some conclusions on the firms are important for some points of the theory and also to understand the choice of the investor. The following chapters will sum up the data, give the more relevant for the study and give the strengths and the weaknesses of the study. Those chapters will present the answer to the questions asked previously. The last chapter will resume the study, explain what the learning gains are and also give some recommendations. Chapter Literature review The Capital Asset Pricing Model (CAPM) has been developed by William Sharpe in 1964, but it is based on earlier works notably those of Harry Markowitz (1952) and William Tobin (1958). [...]

[...] Pearson has a worldwide presence but mostly in North America. They work into 5 different sectors: School, Higher Education, Professional, FT Group and Penguin Group. The profit before taxes rises from £399m to £410m and the dividend per share is 24,2p, a little bit more than the previous year. The increases in the results are mainly due to the development of the company into the group and also the position of world-leader in its category. Tesco Tesco provides a large range of products like the grocery, the wine, the entertainments, finance and insurance and goods for the house. [...]

[...] Those were the first tests that have been realised on the CAPM and where it succeeds. The following tests are more able to look at some failures to the model. Roll (1977) issued a strong critique about the CAPM saying that the CAPM is useless because it is not possible to test it. First because the only test on the CAPM is whether the market portfolio is market variance efficiency: if the proxy of the market portfolio market portfolio is impossible to create and also unobservable because it should contain every investments in every markets) in mean-variance efficiency the CAPM will work; if not the relationship between the expected return and the beta would no more exist. [...]

[...] This is why it is always better to invest in a portfolio of assets rather than in a single firm. The for the portfolio is very high, above 0,63, which reduces the explanatory power of the other factors. Because the results are better than for the portfolio we could expect better expected returns: The results obtains are quite similar to those for the portfolio 1. In this table, the average abnormal return in absolute term is around 0,05, or a deviance from the actual return of 5%. [...]