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Capital Asset Pricing Model (CAPM)

Capital Asset Pricing Model (CAPM)

Introduction

The objective of this paper is to analyse differences and similarities in the classical and neo-classical conceptions of value and to examine their implications for accounting. Specifically, a comparison is conducted between the labour theory of value as advocated by the classical economists and in particular, Marx, and the capital asset pricing model (CAPM), which has become a central theorem in neo-classical capital market analysis. Different strands of thought, Marxist and Neo-Classical, might question the validity of such a project and certainly many of the assumptions required to carry it through. Rather than rejecting important elements of value theory outright, the approach adopted here is to retain and integrate them insofar as they are consistent with the propositions advanced. Therefore, the paper works with the labour theory of value, the law of the tendency of the rate of profit to fall, labour process theory and the notion of objectivity. Critical scholars, including Marxists have rejected or de-emphasised one or more of these elements. The paper also works with neo-classical categories, particularly the elements of risk contained within the conventional CAPM insofar as they are useful. However, modern finance theory has not developed a theory of value independent from assumptions about capital itself. Therefore, whilst these elements have descriptive value they can also be represented as vulgarisations1 of underlying social relationships. Accordingly, the objective is to show that the CAPM is compatible with the labour theory of value, not that the labour theory of value is compatible with the CAPM(Abel ,Dixit ,Eberly ,Pindyck ,2006 ,753).

Comparison Between The Capm And The Dividend Valuation Model

The Capital asset pricing model (CAPM) relates the risk-return trade-off of individual assets to market returns. The basic form of the CAPM is linear relationship between returns on the individual shares and the stock market returns over time. The capital asset pricing model is an attractive to the dividend valuation model and dividend growth model as a method as a model as a method of establishing the cost of equity. The uses of the capital asset pricing model (CAPM) include;

Trying to establish the 'correct' equilibrium market price of company's shares.

Trying to establish the cost of a company's equity, taking account of the risk characteristics of a company's investments, both business and financial risk.

This much is true for any DCF, but a dividend discount model adds an extra layer of difficulty to the forecasts by requiring forecasts of dividends, which means anticipating the dividend policy a company will adopt. As with other DCF models, the discount rate is most likely to be calculated using CAPM.

Fundamental Analysis And Valuation

Shareholders, investors, and lenders have an obvious interest in the value of a firm. In an efficient market, firm value is defined as the present value of expected future net cash flows, discounted at the appropriate risk-adjusted rate of return. A firm's current performance as summarized in its financial statements is an important, but not the only input to the market's assessment of the firm's ...

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