Does the Capital Asset Pricing Model Work?

An important task of the corporate financial manager is measurement of the company’s cost of equity capital. But estimating the cost of equity causes a lot of head scratching; often the result is subjective and therefore open to question as a reliable benchmark. This article describes a method for arriving at that figure, a method […]

by

David W. Mullins, Jr.

by

David W. Mullins, Jr.

From the Magazine (January 1982)

Although its application continues to spark vigorous debate, modern financial theory is now applied as a matter of course to investment management. And increasingly, problems in corporate finance are also benefiting from the same techniques. The response promises to be no less heated. CAPM, the capital asset pricing model, embodies the theory. For financial executives, the proliferation of CAPM applications raises these questions: What is CAPM? How can they use the model? Most important, does it work?

A version of this article appeared in the January 1982 issue of Harvard Business Review.

DM

Mr. Mullins is associate professor of business administration at the Harvard Business School, where he teaches corporate financial management in the MBA and executive programs. He has spent the last several years developing material on modern financial theory for these courses and for the eighth edition of Case Problems in Finance (for which he was a contributing editor), published this year by Richard D. Irwin, Inc. In utilities rate cases and other consulting assignments, Mr. Mullins has applied financial theory.

Does the Capital Asset Pricing Model Work?

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