Capital asset pricing model

Capital asset pricing model

In finance, the capital asset pricing model (CAPM) is used to determine a theoretically appropriate required rate of return of an asset, if that asset is to be added to an already well-diversified portfolio, given that asset's non-diversifiable risk. The model takes into account the asset's sensitivity to non-diversifiable risk (also known as systematic risk or market risk), often represented by the quantity beta (β) in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset.

The formula


E(ri) = Rf + βi(E(rm) - Rf)


where:

E(ri) = return required on financial asset i
Rf = risk-free rate of return
βi = beta value for financial asset i
E(rm) = average return on the capital market