What is a Capital Asset Pricing Model?
The Capital Asset Pricing Model (CAPM) is a financial model used to determine the expected return on an investment based on its risk and the overall market’s performance. Developed by William Sharpe in 1964, the CAPM is one of the most widely used models in finance for pricing risky securities and estimating the expected returns of assets.
The model is based on the principle that an investment’s expected return is a function of its risk and the risk-free rate of return. It assumes that investors are rational and risk-averse, meaning they require compensation for taking on additional risk. The CAPM provides a framework for investors to evaluate the risk and return of an investment relative to the market as a whole.
In this article, we will delve into the components of the CAPM, its assumptions, and its practical applications in finance. We will also discuss the limitations of the model and how it has evolved over time.
