What is a limitation regarding the estimation of Rm in CAPM?

In the context of the Capital Asset Pricing Model (CAPM), the estimation of the market return, denoted as Rm, is typically based on historical data. The limitation of relying on historical figures lies in the assumption that past performance is indicative of future results. This assumption can be problematic because historical returns may not accurately reflect future conditions or changes in the market. Economic factors, changing market dynamics, and shifts in investor behavior can significantly impact returns, leading to discrepancies that could result in an inaccurate estimation of Rm.

Furthermore, using historical averages for estimating market returns does not necessarily account for current market volatility or the unique circumstances that may influence future performance. This could lead to an optimistic or pessimistic bias in predictions, thereby affecting investment decisions made under the assumptions of CAPM. Overall, this reliance on potentially inaccurate historical data is a crucial consideration when estimating Rm within the framework of CAPM.