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
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)
Bibliography
DIMSON, E. and M. MUSSAVIAN, 1999. Three centuries of asset pricing, Journal of Banking and Finance, Volume 23, Issue 12 , December 1999, Pages 1745-1769. [Cited by 12] (1.72/year)
JENSEN, Michael C., 1968. The Performance of Mutual Funds in the Period 1945-1964, The Journal of Finance, Vol. 23, No. 2, Papers and Proceedings of the Twenty-Sixth Annual Meeting of the American Finance Association Washington, D.C. December 28-30, 1967. (May, 1968), pp. 389-416. [Cited by 595] (15.81/year)
SHARPE, William F., 1966. Mutual Fund Performance, The Journal of Business, Vol. 39, No. 1, Part 2: Supplement on Security Prices. (Jan., 1966), pp. 119-138. [Cited by 473] (11.93/year)
TREYNOR, Jack L., 1965. How to Rate Management of Investment Funds, Harvard Business Review 43 (January-February 1966). [Cited by 230] (5.66/year)
TREYNOR, J.L., 1961. Market Value, Time, and Risk. Unpublished manuscript.“Rough Draft” dated. [Cited by 2] (0.04/year)
TREYNOR, Jack L., 1962. Toward a Theory of Market Value of Risky Assets, Unpublished manuscript. A final version was published in 1999, in Asset Pricing and Portfolio Performance: Models, Strategy and Performance Metrics. Robert A. Korajczyk (editor) London: Risk Books, pp. 15-22. [Cited by 33] (0.73/year)
KORAJCZYK, R.A., 1999. Asset pricing and portfolio performance. Risk Books London. [Cited by 2] (0.29/year)
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.