Have we Misinterpreted CAPM for 40 years? A Theoretical Proof

Abstract

The validity of CAPM has been contingent on its security market line hypothesis, which asserts that higher-beta-risk assets should carry higher expected returns. Owing to a lack of empirical support for that hypothesis, many have declared CAPM dead. However, by surrogating assets' following-period ex-post returns as asset expected returns, most empirical studies have misinterpreted CAPM. This paper shows that higher-beta-risk assets will not necessarily generate higher or lower ex-post returns and that CAPM is such a common sense theory that one can literally observe its ex-post return paradigms at work in the daily capital marketplace.