N# N# ^ #N # FIGURE 8.4 The Equity/Bond Split of the Market expected return and beta follows directly from the efficiency of the market portfolio. Thus, if the market portfolio were misspecified, CAPM would produce biased betas. In addition, any test that attempted to validate the CAPM would be fully dependent on how efficient the "market" portfolio is. This in turn implies that the theory is testable only when every individual asset is included in the market portfolio. Some asset classes that come to mind immediately as being difficult to measure include private equity, commodities, real estate, and human capital. Other Assets in the Market Portfolio Publicly traded real estate could be easily added to the market portfolio in the form of the Wilshire REIT index. This index is comprised of companies whose main business activity involves ownership and operation of commercial real estate, and that derive at least 75 percent of revenue from these activities. There are 93 stocks included in the index, selected based on their source of revenue, liquidity, and market capitalization. These stocks are classified into sectors, which include factory outlets, hotels, industrial, local and regional retail, office, storage, apartments, and offices. The total market capitalization for the index is $144.8 billion (as of June 28, 2002). However, there are two issues associated with adding the Wilshire REIT index to the market portfolio as a proxy for real estate. First, the Wilshire REIT index represents publicly traded real estate only in the United States. Adding this index alone to the market portfolio would lead to a distorted regional representation in the market portfolio, as the relative portion of U.S. in the market portfolio will be higher than it is in reality. This may lead to overstating correlations between U.S. asset classes and the market portfolio, subsequently resulting in higher CAPM expected returns. Although there are indexes representing publicly traded real estate in Europe (European Public Real Estate Association, or EPRA) and in Japan (Topixx), they do not regularly provide market capitalizations and often