What Is Roll's Critique?

Roll's critique is an economic idea that suggests that it is impossible to create or observe a truly diversified market portfolio. This is an important idea because a truly diversified portfolio is one of the key variables of the capital asset pricing model (CAPM), which is a widelꦿy used tool among market analysts.

Understanding Roll's Critique

According to Roll's critique, a true "market portfolio" would include every investment in every market, including 澳洲幸运5开奖号码历史查询:commodities, collectibles, and virtually anything with marketable value. Those who still use the capital asset pricing model do so with a market index, such as the 澳洲幸运5开奖号码历史查询:S&P 500, as a proxy for the overall 🍨market return. The critique is an idea that was proposed by economist Richard Roll, who in 1977 theorized that every attempt to diversify a portfolio just becomes an index that attempts to approximate diversification.

The equations that comprise the capital asset pricing model are very sensitive to the formula's variable inputs. A small change in the market's 澳洲幸运5开奖号码历史查询:rate of return (RoR) used in the CAPM formula can have a significant impact on the formula's solution. Because of this and the absence of a true, fully-diversified portfolio, the CAPM formula was considered by Roll to be untestable.

The capital asset pricing model offers a solid foundation for choosing which investments to add to a diversified portfolio, but after learning of Roll's critique and others, many researchers have moved on to using additional, different models. Roll's critique is a reminder of the fact that one can only diversify a portfolio so much, and that investors' attempts to understand and know the market as a whole are just attempts.