Capital Asset Pricing Model and libertarianism
To quote Wikipedia:
In finance, the capital asset pricing model (CAPM) is used to determine a theoretically appropriate required rate of return of an asset, if that asset is to be added to an already well-diversified portfolio, given that asset’s non-diversifiable risk. The model takes into account the asset’s sensitivity to non-diversifiable risk (also known as systematic risk or market risk), often represented by the quantity beta (β) in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset. CAPM “suggests that an investor’s cost of equity capital is determined by beta.”
The CAPM was invented in the 1960s, and became popular among finance people in the 1970s. It was taught in the most basic corporate finance class when I was a college student at Penn in the 1980s. It’s a fine model for valuing stocks and bonds, but what does it have to do with libertarianism?
Libertarians take it as a matter of faith that the amount of money someone earns is exactly equal to the value they create, but they have a tough time explaining exactly why some people earn such massively more money than other people. Thus they picked up on the part of the CAPM which states that more non-diversifiable risk equals higher returns, chose to ignore the “non-diversifiable” part, and applied to this to every rich person. So why is Bill Gates so rich? Because he took more risk. Why is Warren Buffett so rich? Because he took more risk. If you only stopped being lazy and took more risk, you too would be rich!
Carly Fiorina is considered one of the worst CEOs ever, yet she walked away from HP with approximately $200 million more than when she walked in. How was that risky? The regular employees of HP had much riskier jobs, because approximately 30,000 of them were laid off during Carly’s tenure, and they walked away with not much money at all.
Because entrepreneurial risk is mostly diversifiable and not correlated with systemic risk, the CAPM actually teaches us that there would be no return for such risk. And, of course, CEOs and other high-level corporate executives don’t take any risk at all. The higher your job level in corporate America, the all-around better and less risky your job is.
Regarding entrepreneurial risk, because people tend to have an optimism bias and the longshot bias , it’s more likely than not that people are taking too much risk rather than not enough risk. Entrepreneurial risk may be like the risk of the roulette wheel, where 38 people go in and one person wins 35 times their investment while the other 37 lose. (It should be noted that people play roulette despite the fact that it’s known to be rigged in favor of the house, and the same with the massively more popular lottery, but people have an optimism bias and a longshot bias.)