Question

what are drawbacks of using CAPM

Answer 1

Following are some of the drawbacks of CAPM

Risk-free rate

Generally, we take yield on government securities as a risk-free rate. There is no rule as to which maturity of government securities we should look at, but we take short to medium-term maturities. All the maturities will have different yields. Moreover, these yields keep on changing every day, building in some volatility in the model

Ability to borrow and lend at the risk-free rate

CAPM assumes that investors can borrow and lend at risk-free rates. This is not true in real life. Hence the capital market line should actually be less steep than what we get in CAPM

Determination of beta

The determination of beta can become complex. If we are doing it for publicly traded companies, it can be relatively easier but if we are calculating beta for a project or a private company, we need to rely on proxy calculation. We look for comparable companies and projects and based on that estimate beta of our project. In the real world, it is difficult to have two exactly identical companies or projects.
In the case of publicly traded securities, the time frame that we consider for the beta calculation can vary the beta largely. For example, a 2-year beta can be vastly different from 10 years beta. Generally, we can try to encompass one full economic cycle in the calculations but again, that is a gray area