Capital market theory makes reference to multiple forms of analysis that aim to predict the value of securities and the flow of supply and demand in the market.
Types of Capital Market Theory
The capital market theories and pricing models included in the study are Portfolio Theory, the Efficient Market Hypothesis (EMH), the Capital Asset Pricing Model (CAPM), the Arbitrage Pricing Theory (APT), Options Theory and the BlackScholes (8-S) Option Pricing Model.
In this section, we’ll know the model, theory, and hypothesis, all of which are considered integral components of capital market theory. They are:
- Capital asset pricing model
- Modern portfolio theory
- Efficient market hypothesis
Importance of Capital Market Theory
The capital market theory is a description and prediction of the progression of capital. Capital market theory is used to measure the returns wanted by investors and the intrinsic risks involved; it is model that is used to price assets and most commonly used is to price shares.
It is most definitely an important response to financial judgment-making. Besides that, Capital market theory develops a model for all unsafe assets and ads on the portfolio theory.
For the development of capital market theory, the concept of risk-free assets is most crucial. Hence, it is most important for a financial professional to understand the capital market theory as it is an important foundation.
In a nutshell, capital market theory tries to explain and predict the progression of capital (and sometimes financial) markets over time on the basis of one or another mathematical model. CMT is a generic term for the analysis of securities.
However, in terms of trade-off between the returns sought by investors and the inherent risk involved; the capital market theory is a model that seeks to price assets, most commonly, shares.
In general, whenever someone tries to formulate a financial investment or retirement plan, he or she (consciously or unconsciously) employs a theory such as arbitrage pricing theory; capital asset pricing model, coherent market hypothesis, or modern portfolio theory.
The most talked about model in capital market theory is the capital asset, price model. However, in studying CMT managers deal with issues like the role of the capital markets, the major capital markets like in the US; the initial public offerings, and the role of venture capital in capital markets.
Although the theory has got a lot of assumptions as for practitioners of the CMT, it has not lost its significance. It is still as important for retirement, financial, and investment plans.
Modern theories of capital market behavior study the financial markets as complex dynamic processes. The theories themselves are more complex. However, they provide an improved understanding of how the financial markets operate.