Entreprenuers

Introduction

The capital asset pricing model is used in the financial sector, by definition it is used to determine a theoretically appropriate required rate of return of an asset. This asset is usually added to an already well diversified portfolio and it depends on the assets non-diversifiable risk. The model takes into consideration the assets sensitivity to non-diversifiable risks, this can also be described as systematic risk or market risk. In the financial industry this model can be known as CAPM for short and is often represented by the (B) which stands for beta, furthermore the expected return of the market and the expected return of a theoretical risk free asset is also taken into consideration.

The model was introduced in the early 1960’s by several researchers, Jack Treynor, William Sharpe, John Lintner, and Jan Mossin all independently of one another. The model was built off of earlier research that was completed by Harry Markowitz, his research was based on the modernization of portfolio diversification. Sharpe, Markowitz, and Merton Miller went on to all receive the Nobel Prize in Economics for this research in the field of finance and economics.

Before their breakthrough, there were no asset pricing models built from the first principles about the nature of tastes and investment opportunities, there was also nothing to offer any clear predictions of risk and return. Since its inception four decades ago CAPM is still in use today. There are many different applications that the CAPM principle is applied to today such as, estimating the cost of equity capital for firms and evaluating the performance of managed portfolios. It is also taught as the core application in many MBA level investment classes. CAPM is surprisingly simple logic but at the same time acts very powerful, it turns out pleasing predictions on risk measurement and is excellent when measuring the relationship of risk and return.

Some scholars do not like this model...