Hello, people on the Internet. Welcome to my musings: "Mike Talkin'". Yes, you read right: I spell "talkin'" with no G. That is because I have attitude. My topic today is the CAPM and the assumptions that are necessary for it to operate. The Capital Asset Pricing Model is designed to find the required rate of return on a particular asset. Components of the CAPM are β, the risk-free rate and the expected market return. β measures the firm's sensitivity to the market.

The assumptions under the CAPM are: it's a publicly traded firm, many shareholders with well diversified portfolios, management is risk neutral, no agency problems, uninsured risk is uncorrelated with the risk of other securities in the portfolio, and there are no taxes. These assumptions limit the reliability of the model because we don't live in a perfect world. Most shareholders aren't going to be terribly diversified so that right there puts the model into question. Management isn't going to be risk neutral, there will be some level of risk aversion. Lastly, the no taxes assumption doesn't make sense since those are one of the two certain things in life.