A Practitioner’s Guide to the CAPM : An Empirical Study

The most popular method of calculating asset prices is the capital asset pricing model (CAPM). What is the appropriate amount of years to use in the estimation and which variation of the capital asset pricing beta provides the best results? This research looks at the out of sample forecasting capabilities of three popular CAPM ex-post constant beta models from 2005 to 2014. A total of 11 portfolios, five from developed and six from developing markets, are used to test the amount of input years that will reduce the mispricing in both types of markets. It is found that the best beta model to use varies between developed and developing markets. Additionally, in developing markets a shortened span of historical years improves the pricing, contrary to popular studies that use five to ten years of historical data. There are many different CAPM studies implementing various betas, using different data input lengths, and ran in various countries. This study empirically tests the best practices for those interested in successfully using the CAPM for their basic needs. Find that overall the simple ex-post constant beta mispriced by 0.2 (developing) to 0.3 percent (developed). It was better to use short three year estimation windows with the market beta in developing economies and longer nine year estimation windows with the adjusted beta in the developed