Finance

# Capital Asset Pricing Model (CAPM)

The capital asset pricing model (CAPM) is used in finance to determine a theoretically appropriate price of an asset given that asset's non-diversifiable risk. The CAPM formula takes into account the asset's sensitivity to non-diversifiable risk (also known as systematic risk or market risk), in a number often referred to as beta (ß) in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset.
Wikipedia (2006)
Capital asset pricing model - Wikipedia

The CAPM is a model which derives the theoretical required return (i.e. discount rate) for an asset in a market, given the risk free rate available to investors and the risk of the market as a whole.
Wikipedia (2006)
Modern portfolio theory - Wikipedia

The Capital Asset Pricing Model
"The capital asset pricing model, almost always referred to as the CAPM, is a centerpiece of modern financial economics. The model gives us a precise prediction of the relationship that we should observe between the risk of an asset and its expected return."
Bodie, Kane and Marcus (2005)

"The CAPM implies that the expected return of an asset must be linearly related to the covariance of its return with the return of the market portfolio."
Campbell, Lo and MacKinlay (1997), page 181

"CAPM, pronounced ‘cap-m’"
Lofthouse (1994), page 45

Capital asset pricing model (CAPM).
"An equilibrium asset-pricing model that states that the expected return of a security is a linear function of the security's sensitivity to changes in the market's return."
Lofthouse (1994), page 534

• Treynor (1962) (first, yet rarely cited and often incorrectly referred to as “Treynor (1961)”)
• Sharpe (1964)
• Linter (1965)
• Mossin (1966)

## Assumptions

CAPM assumes either 1) normally distributed returns OR 2) mean-variance preferences. So you don't need both to be true, but in practice both are suspect.