The Applicability of the Capital Asset Pricing Model: An Empirical Test

Abstract

The Capital Asset Pricing Model (CAPM) describes the relationship between expected return and risk, offering a simple framework for asset pricing. Despite its popularity, the model has been criticized for relying on unrealistic assumptions and its limited ability to explain returns in practice. This paper reviews the theoretical foundation of CAPM, its extensions, and criticisms, focusing on the Sharpe–Lintner version. Using data from 30 companies over 16 years, we test the model’s validity through three empirical approaches: full sample, sub-sample, and portfolio tests. Results indicate that CAPM can be appropriate for predicting returns of individual stocks, but is unsuitable for portfolios.