Capital Asset Pricing Model


The capital asset pricing model (CAPM) has served as the foundation for pricing risk for nearly fifty years. One author has summarized its acceptance this way:

Modern academic finance is built on the proposition that markets are fundamentally rational. The foundational model of market rationality is the CAPM. The implications of rejecting market rationality as encapsulated by the CAPM are very considerable. In capturing the idea that markets are inherently rational, the CAPM has made finance an appropriate subject for econometric studies. Industry has come to reply on the CAPM for determining the discount rate for valuing investments within the firm, for valuing the firm itself, and for setting sales prices in the regulation of utilities, as well as for such purposes as benchmarking fund managers and setting executive bonuses linked to adding economic value.1

Financial theorists generally have favored using the CAPM as the preferred ...

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