Linearity of the Sharpe-Lintner version of the Capital Asset Pricing Model

Abstract

In the paper the Capital Asset Pricing Model (CAPM) in the original form considered and developed by William Sharpe and John Lintner is entertained and investigated for its empirical validity. The CAPM is one the underlying building blocks of Modern Portfolio Theory and as such is constructed on a number of strong theoretical assumptions concerning the behaviour of financial markets and of investors. In consequence, this model establishes a linear relationship of risky assets returns excess of the riskless rate to market portfolio returns excess of the riskless rate. Its conclusions are weighty and its functional relationship can be deemed as restrictive. On many a ground, the CAPM is thus challenged from the perspective of both a theorist and a practitioner. This empirical study revisits empirical validity of the linear functional form of the CAPM with respect to recent data.