Capital Asset Pricing Model 
Categories: Articles  Books  Dictionary  Faq  Home  Leaders  MBA  Organizations  Search

CAPM 
Summary of the Capital Asset Pricing Model. Abstract 
William F. Sharpe Linter and Treynor 
The Capital Asset Pricing Model (CAPM) is an economic model for valuing stocks, securities, derivatives and/or assets by relating risk and expected return. CAPM is based on the idea that investors demand additional expected return (called the risk premium) if they are asked to accept additional risk. The CAPM model says that this expected return that these investors would demand is equal to the rate on a riskfree security plus a risk premium. If the expected return does not meet/beat the required return, the investors will refuse to invest and the investment should not be undertaken. The CAPM formula is: Expected Security Return = Riskless Return + Beta x (Expected Market Risk Premium)
or: { Another version of the formula is: rRf = Beta x (RM  Rf) }
Beta is the overall risk in investing in a large market, like the New York Stock Exchange. Beta, by definition equals 1,00000 exactly. Each company also has a Beta. A company's Beta is that company's risk compared to the Beta (Risk) of the overall market. If the company has a Beta of 3.0, then it is said to be 3 times more risky than the overall market. Beta measures the volatility of the security, relative to the asset class. A consequence of CAPMthinking is that it implies that investing in individual stocks is pointless, because one can duplicate the reward and risk characteristics of any security just by using the right mix of cash with the appropriate asset class. This is why diehard followers of CAPM avoid stocks, and instead build portfolios merely out of lowcost index funds.
Note! The
Capital Asset Pricing Model
is a ceteris paribus model.
It is only valid within a special set of assumptions. These are: William Sharpe was the 1990 Nobel price winner for Economics "For his contributions to the theory of price formation for financial assets, the socalled Capital Asset Pricing Model (CAPM)." Book: William F. Sharpe  Portfolio Theory and Capital Markets  Book: Harry M. Markowitz  MeanVariance Analysis in Portfolio Choice and Capital Markets  Book: Mary Jackson  Advanced modelling in finance using Excel and VBA  Compare with CAPM: Real Options  RAROC  Plausibility Theory  Operations Research  Relative Value of Growth 
About us  Advertise  Privacy  Support us  Terms of Service ©2019 Value Based Management.net  All names ™ by their owners
