Arbitrage pricing modelpoint is selected, for example annual rates of 6.5 per cent in the period 1960 to 1978,
4.5 per cent for 1970 to 1978 and 0.9 per cent for 1973 to 1978.
Dimson, Marsh and Staunton (2002) show that the average excess of equity returns
over that from treasury bills (the risk premium) was 4.5 per cent p.a. (in real terms) in
the UK during the period 1900 to 2001, though it varied from year to year. Dimson et
al. also show that the equity premium varied significantly on an international basis
over this period, as they also do for shorter recent periods.
Probably the best approach to the problem of estimating the risk premium for the
market would be to base it on this long-term average of about 4.5 per cent p.a. (for UK
investments).7.11 Use of CAPM in practice
Whatever the problems with the model, it certainly seems as if those making real
investment decisions in practice use CAPM to help them to derive the appropriate dis-
count rate for NPV appraisals. Pike (1996) found that while none of his survey respond-
ents used CAPM in 1975 or 1980, by 1986, 16 per cent reported using it, and by 1992,
20 per cent. Three surveys were conducted in 1997 involving large UK businesses.
McLaney, Pointon, Thomas and Tucker (2004) undertook a postal survey of a sample
of 193 of the 1,292 businesses fully listed on the London Stock Exchange and found
that 47 per cent of them used CAPM. Gregory, Rutterford and Zaman (1999) inter-
viewed financial managers of 18 of the largest 100 UK businesses and found that 14 of
these (78 per cent) used CAPM. Al-Ali and Arkwright (2000) carried out a postal sur-
vey of 73 of the largest 450 UK businesses and found that 85 per cent of the respond-
ents used CAPM. Alkaraan and Northcott (2006) found, that in 2002, 43 per cent of the
businesses surveyed used it. The discrepancy between these findings may well be
explained by the sizes of businesses involved, though the surveys tended to concen-
trate on larger UK businesses.
In the USA, Graham and Harvey (2001) found that 73 per cent of the larger US busi-
nesses surveyed in 1999 used CAPM ‘always or almost always’. They found larger
businesses more likely to use CAPM than smaller ones.
It seems that in both the UK and USA, CAPM is used by a large proportion of large
businesses. It seems likely that this is true in much of the rest of the world as well. The
existence of numerous commercial services providing betas adds further weight to
the evidence that CAPM is an important approach in practice.
It will be interesting to see the level of usage of CAPM in the future. Most of the
research that seriously questioned the practical validity of CAPM has only emerged in
the early 2000s.7.12 Arbitrage pricing model
The fact that tests of CAPM have shown beta not to be a good indicator of the re-
lationship between the level of risk and the expected risk premium caused researchers
to look at other approaches. One such approach led to the development
of the arbitrage pricing model(APM). The logic of this model is that there is not a
single factor that explains the risk/risk premium relationship, as is suggested by
CAPM, but a number of them. The APM, which was developed by Ross (1976), holds‘