THEORETICAL FLAWS IN THE USE OF THE CAPM FOR INVESTMENT DECISIONS

Carlo Alberto Magni

MPRA Paper from University Library of Munich, Germany

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.

Keywords: Capital budgeting; CAPM; investment decisions; nonadditivity; framing effects (search for similar items in EconPapers)
JEL-codes: G11 G12 G30 G31 (search for similar items in EconPapers)
Date: 2005-12, Revised 2007-11
New Economics Papers: this item is included in nep-cfn and nep-ppm
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:6330

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