The Application of CAPM Model in Stocks Investment and Alternatives Models of CAPM

The relationship between systematic risk-i.e., the broad risks involved in investing, and the expected return on assets, especially stocks, is explained by the Capital Asset Pricing Model (CAPM). Investors can use the CAPM approach to determine an expected return(E(Ri)) and compare it to the required return (Ri). It is recommended to invest in stocks where the required return exceeds the expected return. The CAPM is popular among investors due to its simplicity and accuracy. However, it is often criticized for its limitations as a single-factor model, as it only accounts for systematic risk, which is measured by Beta. This paper will discuss its limitations, including the limited assumptions it makes, its inability to be generalized to certain areas, and the fact that it only includes systemic risks. Some theories were then put forth to modify these shortcomings. This paper will also examine alternative models including the Arbitrage Pricing Theory (APT) and the Fama-French Three-Factor Model, which have been suggested as replacements for CAPM.