CAPM’s Assumptions Supplant Heterogeneous Human Persons with an Army of Homogeneous Robots

The current mainstream in investment appraisal relies on input parameters within the income approach that are much different from what investment theory requires. It is based upon neoclassical finance theory and neglects the crucial personal perspective in favor of a questionable “objective” market perspective (Matschke, and Brösel, 2013, pp. 26–27). Though the prevalent mainstream discounted cash flow (DCF) methods are also based upon the income approach, they are inadequate as a decision tool (e.g., Rapp, 2014b, p. 1067). The main reason for this diagnosis is the application of finance-theory based models within current DCF methods (Hering, 2014, p. 263).

In these methods, the discount rate is usually, at least partly, assessed using the capital asset pricing model (CAPM) (Koller, Goedhart, and Wessels, 2010, p. 234). Instead of considering the essential personal endogenous marginal interest rate, the CAPM aims at the determination and application of an “objective” discount rate (Hering, 2015, p. 307). In order to measure an, at least hypothetically, objective discount rate, the CAPM must rely upon several restrictive assumptions (e.g., Perridon, Steiner, and Rathgeber, 2012, p. 546, Hering, 2015, p. 297). These include a perfect capital market (which includes the existence of a single market interest rate for both investments and lending; unlimited access to lending independent of debt ratio, credit-worthiness, credit amount and time pattern; symmetric distribution of information; and the absence of taxes as well as transaction costs) and economic agents with both homogeneous expectations and a standardized risk appetite (µ-σ-principle). Basically, CAPM’s assumptions supplant heterogeneous human persons with an army of homogeneous robots. Because the subjective values of homogeneous robots coincide, the model can generate a (hypothetical) single objective market value (Matschke, and Brösel, 2013, p. 27). The uniformity of economic agents in the CAPM leads finally to the market portfolio which includes every risky asset and which is held by every single investor. In other words, in the CAPM world, everybody owns everything (Hering, 2015, pp. 298–299). The sole ownership of any company is, by definition, impossible. Thus, the purchase or sale of an entire company is excluded as well. Nevertheless, the CAPM is applied for the investment appraisal of entire businesses in preparation of merger and acquisition decisions all over the world every single day.

—Jeffrey M. Herbener and David J. Rapp, “Toward a Subjective Approach to Investment Appraisal in Light of Austrian Value Theory,” Quarterly Journal of Austrian Economics 19, no. 1 (Spring 2016): 20-22.