Analyse the Limitations of the Capital Asset Pricing Model (CAPM) in Risk Measurement Using the Monte Carlo Simulation Method

DOI

10.2991/978-94-6463-811-0_75How to use a DOI?

Keywords

CAPM; Monte Carlo Simulation; Limitation analysis; Beta

Abstract

This paper critically examines the limitations of the Capital Asset Pricing Model (CAPM) in financial risk measurement by applying the Monte Carlo simulation method. While CAPM remains a foundational model in asset pricing and investment decision-making due to its theoretical simplicity and operability, its reliance on idealised assumptions—such as rational investors, frictionless markets, and normally distributed returns—often diverges from the complexities of real-world financial markets. Using historical data from the Shanghai Stock Exchange and simulating asset return paths through geometric Brownian motion, this study conducts 10,000 iterations to estimate risk indicators, including expected return, standard deviation, and Value at Risk (VaR). The findings reveal that CAPM underestimates risk by oversimplifying market dynamics and relying solely on the beta coefficient, which may fluctuate in volatile markets. In contrast, Monte Carlo simulation captures a broader distribution of outcomes, accounting for market uncertainties and extreme events more effectively. This study not only underscores the inadequacies of CAPM in dynamic environments but also highlights the importance of incorporating simulation-based techniques for more robust risk evaluation. The results offer theoretical insights and practical guidance for investors and financial institutions aiming to enhance the precision and adaptability of their risk assessment frameworks.

Copyright

© 2025 The Author(s)

Open Access

Open Access This chapter is licensed under the terms of the Creative Commons Attribution-NonCommercial 4.0 International License (http://creativecommons.org/licenses/by-nc/4.0/), which permits any noncommercial use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons license and indicate if changes were made.

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TY  - CONF
AU  - Ziran Chang
PY  - 2025
DA  - 2025/08/14
TI  - Analyse the Limitations of the Capital Asset Pricing Model (CAPM) in Risk Measurement Using the Monte Carlo Simulation Method
BT  - Proceedings of the 2025 5th International Conference on Enterprise Management and Economic Development (ICEMED 2025)
PB  - Atlantis Press
SP  - 717
EP  - 728
SN  - 2352-5428
UR  - https://doi.org/10.2991/978-94-6463-811-0_75
DO  - 10.2991/978-94-6463-811-0_75
ID  - Chang2025
ER  -