THEORETICAL FLAWS IN THE USE OF THE CAPM FOR INVESTMENT DECISIONS

Magni, Carlo Alberto (2005): THEORETICAL FLAWS IN THE USE OF THE CAPM FOR INVESTMENT DECISIONS.

Abstract

This paper uses counterexamples and simple formalization to show that the standard CAPM-based Net Present Value may not be used for investment valuations. The reason is that the standard CAPM-based capital budgeting criterion implies a notion of value which does not comply with the principle of additivity. Framing effects arise in decisions so that different descriptions of the same problem lead to different choices. As a result, the CAPM-based NPV as a tool for valuing projects and making investment decisions is theoretically unsound, even if the CAPM assumptions are met.

• Item Type: MPRA Paper
• Language: English
• Keywords: Capital budgeting, CAPM, investment decisions, nonadditivity, framing effects
• Subjects: G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G3 - Corporate Finance and Governance > G31 - Capital Budgeting ; Fixed Investment and Inventory Studies ; Capacity; G - Financial Economics > G3 - Corporate Finance and Governance > G30 - General

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