Capital Market Theory: Is It Relevant to Practitioners?

Nawrocki, David
October 1997
Journal of Financial Planning;Oct97, Vol. 10 Issue 5, p97
Academic Journal
The article explores the capital asset pricing model (CAPM) discusses the strengths and weaknesses of this classic model. The CAPM is commonly confused with portfolio theory. Portfolio theory is simply the use of statistical and mathematical programming techniques to derive optimal trade-offs between risk and return. To be fair, CAPM provides some useful insights. It provides the concept of diversifiable risk and non-diversifiable risk. Clearly, an understanding of capital market theory is an important foundation in training a financial professional. Investor behavior is mote complex than the simple rational investor of traditional theories. It's not very difficult to add transaction costs, information costs, and less-than-perfect information systems to the current model. To summarize, the classic CAPM theory is too simplistic. Modern theories of capital market behavior study the financial markets as complex dynamic processes; the theories themselves are more complex. However, they provide an improved understanding of how the financial markets operate. This understanding of the financial markets is crucial to the investment decision-making process and therefore, to practitioners.


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