The Capital Asset Pricing Model in Economic Perspective

43 Pages Posted: 26 Jun 2013 Last revised: 25 Feb 2020

Date Written: November 11, 2014


The Capital Asset Pricing Model (CAPM) is theoretically incomplete in its demand-side focus, risk-averse investors, and internally inconsistent homogeneous beliefs; is not conclusively supported empirically; and yet it legitimizes a notion that investors can earn higher returns by bearing un-diversifiable risk. Our paper does not merely extend the CAPM with more realistic assumptions, it completes its original framework by including (1) risk-taking investors in the investor population, (2) investors who can have heterogeneous expectations or beliefs — an overlooked but required condition for the CAPM to be an internally consistent and meaningful model of competitive financial asset pricing under uncertainty, and (3) a positive-sloped short-run supply curve based on a reasonable interpretation of the nature of financial asset trade. Upon a complete economic interpretation, it is shown the equilibrium (systematic) risk-rate of return relationship depends on whose aggregate trading activity dominates, risk-averse or risk-taking investors’. There is no universal, or even general, positive relationship between systematic risk and rate of return. This has far-reaching implications for investors and investment advisors who serve them.

Keywords: economics, finance, financial economics, capital asset pricing model, CAPM, risk-return paradigm, heterogeneous beliefs, William Sharpe, John Lintner, Jan Mossin, Jack Treynor, Fischer Black, Harry Markowitz, Bernell Stone, Michael Guth, Edward Miller, Joseph Williams,Benoit Mandelbrot,Hersh Shefrin

JEL Classification: D01, D46, D53, D81, D84, G02, G11, G12, G31, J26, M21

Suggested Citation

Dawson, Peter C., The Capital Asset Pricing Model in Economic Perspective (November 11, 2014). Author's version. First published as: Dawson, Peter C. 2015. "The Capital Asset Pricing Model in Economic Perspective", Applied Economics, Vol. 47, No. 6, pp. 569-598., Available at SSRN: or

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