Capital asset pricing model
The capital asset pricing model (or CAPM, as it is universally known) estimates the expected return for a firm’s stock. The calculation uses the prevailing risk-free rate, the stock’s trading history and the return that investors are expecting from owning shares.
When to use it
- To estimate the price you should pay for a security, such as a share in a company.
- To understand the trade-off between risk and return for an investor.
CAPM was developed by William Sharpe. In 1960, Sharpe introduced himself to Harry Markowitz, inventor of ‘modern portfolio theory’, in search of a doctoral dissertation topic. Sharpe decided to investigate portfolio theory, and this led him to a novel way of thinking ...