capital asset pricing model


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Capital asset pricing model (CAPM)

An economic theory that describes the relationship between risk and expected return, and serves as a model for the pricing of risky securities. The CAPM asserts that the only risk that is priced by rational investors is systematic risk, because that risk cannot be eliminated by diversification. The CAPM says that the expected return of a security or a portfolio is equal to the rate on a risk-free security plus a risk premium multiplied by the asset's systematic risk. Theory was invented by William Sharpe (1964) and John Lintner (1965). The early work of Jack Treynor is was also instrumental in the development of this model.

Capital Asset Pricing Model

A model that attempts to describe the relationship between the risk and the expected return on an investment that is used to determine an investment's appropriate price. The assumption behind the CAPM is that money has two values: a time value and a risk value. Thus, any risky asset or investment must compensate the investor for both the time his/her money is tied up in the investment and the investment's relative riskiness. This compensation must be in addition to the risk-free rate of return. There are a number of variations on the CAPM, notably the multifactor CAPM and the two-factor model. The CAPM is calculated according to the following formula:

ra = rf + Betaa(rm - rf)

where:

ra is the asset price,
rf is the risk-free rate of return,
Betaa is the risk premium, and

rm is the market rate of return.

capital asset pricing model

a model that relates the expected return on an ASSET or INVESTMENT to its risk. Assets that show greater variability in their annual returns generally need to earn higher expected average returns to compensate investors for the variability of returns. See RISK AND UNCERTAINTY.
References in periodicals archive ?
Hill and Fairley (1979) found that "fair" profit rates determined by the Capital Asset Pricing Model were close to historical profit rates than to traditional rule-of-thumb profit rates used in regulation.
Kayo, 2014, "The Earnings/Price Risk Factor in Capital Asset Pricing Models.
In this paper the cost of equity was calculated using the Capital Asset Pricing Model (Sharpe, 1964; Litner, 1965; Mossin, 1966) and beta was calculated according to the methodology proposed by Wolski (2010).
Impact of capital asset pricing model (CAPM) on Pakistan (The case of KSE 100 Index).
The Intertemporal Capital Asset Pricing Model with Dynamic Conditional Correlations.
As far as the third element is concerned, or the third input variable of the Capital Asset Pricing Model, that is, the market risk premium, it is difficult to affirm that there is consensus.
Redmond and Cubbage (1988) applied modern portfolio theory and the nominal capital asset pricing model (CAPM) in evaluating timber prices of various species, products, and regions.
This led to the capital asset pricing model and has been followed by a flood of financial formulas.
He examined the Myers-Cohn (1987) and the internal rate of return methods, and showed that in the absence of taxes, the application of each method produces a return on equity, period by period, which is consistent with the Sharpe's (1964) Capital Asset Pricing Model.
En el contexto actual, en el cual se preve el ingreso de capitales a nuestro pais como un flujo de inversiones, esta obra, publicada por ESAN, se convierte en una importante contribucion a la discusion acerca de la determinacion del costo de capital para evaluar inversiones en paises emergentes como el nuestro, bajo un enfoque de aplicabilidad del modelo del Capital Asset Pricing Model (CAPM) como un metodo para incluir el riesgo en la toma de decisiones de inversion.
The main conclusions of the research by the EDHEC-Risk Institute are that, first, a cap-weighted stock market index is not the market portfolio of financial theory (the Capital Asset Pricing Model (CAPM) theory is often evoked to show that cap-weighted stock market indices are efficient portfolios and attractive investments).

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