Unveiling influential factors in the capital asset pricing model: A novel approach utilizing Taguchi method

Abstract

This study uses a Design of Experiment (DOE) approach and the Taguchi method to examine how different factors affect the expected return within the framework of the CAPM. The Capital Asset Pricing Model (CAPM) is a financial framework that forecasts an investment’s expected return by taking into account its systematic risk. This model factors elements like the risk-free rate, market risk premium, and beta to ascertain the expected return for a given asset. Typically, historical market data and financial analysis provide the inputs for CAPM. This method, frequently used in manufacturing and engineering, is modified for use in the financial domain to evaluate the importance of variables like beta, market risk premium, and the risk-free rate. The research identifies the factors that influence investment performance and shows how much each factor contributes to the expected returns. It is possible to ascertain each factor's percentage contribution to the expected return through statistical analysis. This work improves knowledge of CAPM and creates opportunities for improving investment decision-making processes by bridging the gap between financial theory and experimental design. Financial practitioners can achieve more reliable and accurate investment return forecasts by incorporating DOE techniques into their existing analytical toolkit.