Question

8. Tests of the CAPM Aa Aa The CAPM is one of the most extensively tested models in finance. The following statements describe the assumptions, methods, and findings of several of these studies. Based on your understanding of these issues, which of the following statements are true? Check all that apply Most tests of the CAPM have used portfolios of securities rather than individual stocks, due to the instability of the betas of individual securities In theory, the CAPM should be applied to only stocks and not to other types of financial assets Two important hypotheses addressed in tests of the CAPM and SML are that (1) a linear relationship exists between the required return on a security and its beta and (2) the required return of a stock or portfolio exhibiting a beta of 1.0 should equal the required market return (rM) Based on Levy's 1971 examination of the stability of the betas of both individual securities and portfolios of 10 or more randomly selected stocks, it is logical to conclude that the CAPM is a better concept for structuring investment portfolios than for estimating the required return of individual securities Read the following information that addresses the empirical tests that have been conducted on the CAPM and determine whether the information is accurate: The many tests of the CAPM have concluded that the model is extremely useful in using ex post data to calculate true ex ante required returns. Is this information accurate? O No Yes

please answer

Answer 1

Statement one is false since the Capital Asset pricing model uses individual securities rather than portfolios.

Statement 2 is also false because in theory the CAPM model is applicable to all financial assets.

Statement 3 is true since the required return of a security varies in indirect proportion to its beta. Also a beta of 1 implies that the required return of a stock should equal the required market return.

Statement four is also true since the study was similar to that of Blume which concluded that the Capital Asset pricing model is a better Concept for structuring investment portfolios.

Finally the given statement is true because we usually performed test of the Capital Asset pricing model using historical or ex-post values. The model is in an ex Ante form.