Question

Describe some capital market imperfections that render the CAPM (Capital Asset Pricing Model) a less than complete model of reality, especially for application to real estate.

Describe two different levels, or foci, at which we might hope to apply the CAPM to real estate.

The CAPM was originally (and is still primarily only) applied within the stock market. Nevertheless, describe the two types of corrections or customizations to this narrow stock market application that allow the classical single-factor CAPM to be applied

Answer 1

CAPM holds certain assumptions which cannot wholly be considered realistic always.One of the important considerations of CAPM is that the investor hold diversified portfolio where unsystematic risk is totally eliminated. However real estate assets have a low correlation with market securities which makes the CAPM less suitable for application to the real estate.Also the assumption of identical investment horizon is not applicable to the real estate market.

The first thing that we can do to aplly CAPM to real estate is that we can adjust the beta in order to take into account the diffrent investment horizon and the transaction costs that are applicable. Also we should take the market return in relation to the real estate assets and not the whole portfolio of market securities.

two types of corrections

In my opnion customizations can be made in estimating the beta of a security as well as the portfolio.We should definitely consider the diffrerent time periods while computing the beta of a security instaed of a single time horizon. Further we should take into accoumt the correlation between diffreent securities in a portfolio. I think these changes can make CAPM approach realistic to some extent if not completely modern.