CAPM (Capital Asset Pricing Model);

1. is a set of narrative theory framework model.

2. It is used to describe how the price of assets in the market is determined.

Its purpose is:

1. Describe the relationship between market risk and expected return of securities when the supply and demand of securities reach a balance.

2. Assist investors to create the best investment portfolio, evaluate and determine the value of various securities, so as to make appropriate investment decisions. For more than 20 years since the mid-1980s, with the progress of computing technology and the establishment of major financial market research databases, financial economists and scholars have conducted extensive empirical tests on financial theory from different angles. The new findings fundamentally deny the conclusion of traditional asset pricing theory. Mainly in the following aspects: 1. The average return of a single asset, portfolio, fund and investment strategy is not commensurate with its beta coefficient. CAPM is not a suitable model to measure risk. 2. The income is predictable. First of all, dividend yield, short-term bond yield, long-term and short-term treasury bond yield difference, Phnom Penh junk bond yield difference and business cycle indicators can predict the time series changes of stock returns. The representative studies in this field are Fama and French (1989), Letau and Ludvigson(2000). Second, stock volatility changes with time. Third, after adjusting the risk according to CAPM, some funds outperformed the market. Although the further research results of Carhart( 1997) show that the extraordinary performance of funds is attributed to the mechanical "style" rather than the excellent stock selection level of fund managers. Fourth, stock returns show strong medium-term kinetic energy and long-term regression tendency. Since Jegadeesh and Titman( 1993) discovered the existence of "kinetic energy" in the American stock market, some scholars have conducted numerous out-of-sample tests on the stock markets outside the United States, and found that all stock markets except a few emerging markets have a tendency of "kinetic energy" in the medium term and "return" in the long term. 3. Three-factor and four-factor asset pricing models have strong explanatory power to the changes of expected returns of stocks. The representative studies of this mask are Fama and France (1993). They proved that the three-factor model (market factor, scale factor and value factor) can explain the 70%-80% change of American stock returns. Similar empirical evidence has been found in other markets, including the emerging stock market in China. The obvious limitation of the three-factor model is that it cannot explain the phenomenon of income kinetic energy. Adding kinetic energy factor into three factors, namely four-factor pricing model, can enhance the ability of asset pricing model to explain income changes. Although the three-factor and four-factor models are generally accepted by financial theorists, there are great disputes about the explanation of these factors. Fama and French believe that three factors represent risk factors, so the three-factor model is an extension of the traditional asset pricing theory. Behavioral finance school believes that scale factor, value factor and kinetic energy factor reflect the results of investors' internal behavior deviation. The controversy in this regard is still inconclusive. However, one thing is certain, kinetic energy is hardly related to risk factors. As can be seen from the above discussion, the traditional asset pricing theory is facing an embarrassing situation of lack of empirical support. In the process of examining and reflecting on this subject, behavioral finance, which uses psychology, sociology and behavior to study people's decision-making behavior in financial activities, has become the focus of academic attention. Behavioral finance really ushered in development after the 1980s. In the predicament that the mainstream financial model constantly deviates from empirical evidence, along with the ProspectTheory founded by Kahneman of Princeton University and Tversky of Stanford University, financial economists expect to find a breakthrough in the development of financial theory, especially asset pricing theory, from behavioral finance. In the traditional asset pricing theory, the actor is presupposed as a rational person in a complete sense. Such a rational person not only has rationality, but also can use rationality to compare costs and benefits under any circumstances, so as to make decisions to maximize utility. On this basic premise, behavioral finance is very different from mainstream finance. Behavioral finance does not fully affirm the universality of human rationality. Many times, human decision-making is not based on rational expectation, risk avoidance and utility maximization. Behavioral finance is based on two basic behavioral assumptions: 1) deep psychological deviation, avoiding uncertainty, overconfidence and conservative decision-making; 2) Framework dependency. People's decision-making is influenced by the specific thinking framework of decision makers, which is mainly manifested in avoiding losses and regrets. Starting from several early studies, including Shiller's (1981) finding the abnormal fluctuation of American stock returns and inferring the irrationality of investors, based on behavioral assumptions, financial economists reflect on asset pricing, enriching and developing asset pricing theory. For example, the Behavioral Asset Pricing Theory (BAPM) proposed by Shefrin and Statman( 1994) not only accepts the market efficiency to a limited extent, but also inherits the bounded rationality pursued by behavioral finance. Barberis et al. (1998) established a theoretical model to analyze the impact of investor sentiment on asset prices. Daniel et al. (1998) explained the common phenomenon of medium-term (3- 12 months) return kinetic energy and long-term (3-5 years) return with behavioral bias. Investor behavior deviation not only affects the price of securities such as stocks, but also affects the price decision of derivatives. However, academic research in this field is still in its infancy. For example, it is found that deep psychological deviation may lead to a "smile" in the graph of implied volatility of options, that is, implied volatility decreases with the increase of option exercise price, and its theoretical implied volatility should have nothing to do with exercise price. In addition, investor sentiment also affects the price or implied volatility of options. For example, many investors think that the buy/sell ratio is a good indicator to measure investors' mood. Moreover, the derivatives market is similar to the stock market, and there is also an "overreaction" phenomenon. Stein( 1987) illustrates the overreaction of stock index options market with empirical evidence. Wang Heyu (2003) found that "overreaction" is common in the 24 most active futures markets in the United States.