The Capital Asset Pricing Model in the 21st Century
Analytical, Empirical, and Behavioral Perspectives

This book bridges behavioral economics and the classical models in finance to show that there is no contradiction between them.

Haim Levy (Author)

9781107006713, Cambridge University Press

Hardback, published 31 October 2011

458 pages, 63 b/w illus. 32 tables
22.9 x 15.2 x 3 cm, 0.84 kg

'Here in one volume is a presentation, analysis, and discussion of some of the key pillars of modern financial theory: mean-variance analysis, the capital asset pricing model, expected utility theory, and cumulative prospect theory. Haim Levy presents each theory carefully and completely, discusses the relevant arguments and evidence, and argues convincingly that practitioners and academics should adopt a synthesis that incorporates major elements of these approaches. A real tour de force from one of the major contributors to the field.' William F. Sharpe, Nobel Laureate, Stanford University

The Capital Asset Pricing Model (CAPM) and the mean-variance (M-V) rule, which are based on classic expected utility theory, have been heavily criticized theoretically and empirically. The advent of behavioral economics, prospect theory and other psychology-minded approaches in finance challenges the rational investor model from which CAPM and M-V derive. Haim Levy argues that the tension between the classic financial models and behavioral economics approaches is more apparent than real. This book aims to relax the tension between the two paradigms. Specifically, Professor Levy shows that although behavioral economics contradicts aspects of expected utility theory, CAPM and M-V are intact in both expected utility theory and cumulative prospect theory frameworks. There is furthermore no evidence to reject CAPM empirically when ex-ante parameters are employed. Professionals may thus comfortably teach and use CAPM and behavioral economics or cumulative prospect theory as coexisting paradigms.

1. Overview
2. Expected utility theory
3. Expected utility and investment decision rules
4. The mean-variance rule
5. The capital asset pricing model (CAPM)
6. Extensions of the CAPM
7. The CAPM cannot be rejected: empirical and experimental evidence
8. Theoretical and empirical criticisms of the M-V rule
9. Prospect theory and expected utility
10. Cumulative decision weights: no dominance violation
11. M-V rule, the CAPM, and the cumulative prospect theory: coexistence.

Subject Areas: Applied mathematics [PBW], Business & management [KJ], Finance & accounting [KF], Economic statistics [KCHS]