Discuss the assumptions of capital asset pricing model (CAPM) along with limitations.

Capital asset pricing model (CAPM) helps to work out the required rate of return required by investor in the form of equity investment. It establishes a linear relationship between the required rate of return of a security and its beta (β). CAPM model is based on certain assumptions: Market efficiency: the capital market efficiency means that share prices reflect all available information. Risk aversion and mean variance optimization: investors are risk averse. They evaluate a security's return and risk in terms of expected return and variance or standard deviation respectively. They prefer the highest expected return for a given level of risk. This implies that the investors are mean variance optimizers and they form efficient portfolios. Homogenous expectations: all investors have the same expectations about expected returns and risks of securities. Single time period: all investors' decisions are based on a single time period. Risk-free rate: all investors can lend and borrow at a risk-free rate of interest. There exist no taxes whether personal or corporate. Transaction in securities is without any transaction cost. CAPM suffers from following limitations: It is based on unrealistic assumptions: CAPM is based on a number of assumptions that are far from reality. Therefore CAPM may not accurately explain the investment behavior of investors and beta may fail to capture the risk of investment. It is difficult to test the validity of CAPM Betas do not remain stable over time