# 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.
Copyright © 2012, Campbell R. Harvey. All Rights Reserved.

## 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.
Farlex Financial Dictionary. © 2012 Farlex, Inc. All Rights Reserved

## 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.
Collins Dictionary of Economics, 4th ed. © C. Pass, B. Lowes, L. Davies 2005
References in periodicals archive ?
Multifactor Capital Asset Pricing Model and the Jordanian Stock Market (Doctoral dissertation, Walden University).
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." Annual Conference, Port of Spain, Trinidad and Tabago.
3.1 The Inter-temporal Capital Asset Pricing Model (ICAPM)
The Capital Asset Pricing Model (CAPM), Short Sell Restriction and Related Issues, The Journal of Finance, Vol.
Still, higher expectations are placed upon the Capital Asset Pricing Model (CAPM) and the Arbitrage Pricing Theory (APT).
Markowitz's optimization approach is the basis of possibly every SAA and the expected return forecasts used as inputs in the SAA development process are derived from the Capital Asset Pricing Model (CAPM).
Since no beta factor yet exists for this, let's use a proxy figure based on the plastics industry to approximate the risk and hence (using the capital asset pricing model) the adjusted cost of equity of the new project.
Under the framework of Fisher's hypothesis and the real capital asset pricing model, we investigated stumpage prices' ability to hedge against inflation in 12 US southern timber regions using Timber Mart-South data.
This led to the capital asset pricing model and has been followed by a flood of financial formulas.

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