Capm

Journal of Economic Perspectives—Volume 18, Number 3—Summer 2004 —Pages 25– 46

The Capital Asset Pricing Model: Theory and Evidence
Eugene F. Fama and Kenneth R. French

T

he capital asset pricing model (CAPM) of William Sharpe (1964) and John Lintner (1965) marks the birth of asset pricing theory (resulting in a Nobel Prize for Sharpe in 1990). Four decades later, the CAPM is still widely used in applications, such as estimating the cost of capital for firms and evaluating the performance of managed portfolios. It is the centerpiece of MBA investment courses. Indeed, it is often the only asset pricing model taught in these courses.1 The attraction of the CAPM is that it offers powerful and intuitively pleasing predictions about how to measure risk and the relation between expected return and risk. Unfortunately, the empirical record of the model is poor—poor enough to invalidate the way it is used in applications. The CAPM’s empirical problems may reflect theoretical failings, the result of many simplifying assumptions. But they may also be caused by difficulties in implementing valid tests of the model. For example, the CAPM says that the risk of a stock should be measured relative to a comprehensive “market portfolio” that in principle can include not just traded financial assets, but also consumer durables, real estate and human capital. Even if we take a narrow view of the model and limit its purview to traded financial assets, is it
1 Although every asset pricing model is a capital asset pricing model, the finance profession reserves the acronym CAPM for the specific model of Sharpe (1964), Lintner (1965) and Black (1972) discussed here. Thus, throughout the paper we refer to the Sharpe-Lintner-Black model as the CAPM.

y Eugene F. Fama is Robert R. McCormick Distinguished Service Professor of Finance,
Graduate School of Business, University of Chicago, Chicago, Illinois. Kenneth R. French is Carl E. and Catherine M. Heidt Professor of Finance, Tuck