I have two questions about the CAPM model: the first is theoretical while the second is related to observed market data.
First question: let's say we have company A and company B and we want to estimate their expected returns within the CAPM model.
In this model the percentage of systematic risk is given by the $R^2$ of the regression of an investment's returns and market portfolio returns. Let's say that company A has 30% systematic risk while company B has 80% systematic risk. Then CAPM tells us that the Beta of an investment (market returns coefficient in the CAPM regression) is to be used as a scaling factor of the market portfolio expected extra-return in order to obtain the investment expected extra-return.
Let's now suppose that the two companies have the same Beta.
What are the implications of this problem in the CAPM model? Is the model suggesting that Company A has a much greater total risk than Company B?
Second question: if we use real data to estimate Betas and we obtain the following results:
- Beta = 1.41
- CAPM estimated expected return = 11%
but the historical average return for the same period is 60% (with a volatility of 70%).
What would most likely be the CAPM assumption that did not hold?