CAPM
Test the market-beta baseline for expected returns
CAPM is an equilibrium model linking expected excess return to exposure to the market portfolio. Empirical work estimates market beta and examines whether average returns or regression alphas are consistent with the model. A single-index market regression is a statistical tool; testing CAPM additionally requires choices about a market proxy, risk-free return and the cross-sectional pricing restriction.
Choose CAPM as a transparent baseline for risk adjustment or an asset-pricing hypothesis when matched return, market-proxy and risk-free series are available. Compare conclusions with plausible multifactor alternatives.
Strengths
- Parsimonious benchmark with an interpretable market exposure
- Makes a clear expected-return restriction available for testing
Limitations
- The theoretical market portfolio is not directly observed
- Omitted priced exposures and unstable beta can affect conclusions
Know the boundary
A statistically significant market beta does not validate CAPM or predict a guaranteed realised return.