The Capital Asset Pricing Model

The Capital Asset Pricing Model is a popular asset pricing model in Finance. It is used to determine the expected rate of return of a risky asset. It says that the expected return on a risky asset is equal to the risk-free rate plus a risk premium.

The risk premium is a measure of non-diversifiable risk and is calculated using the asset’s Beta. CAPM considers only systematic risk (non-diversifiable risk) as the security specific risk (unsystematic risk) can be diversified away.

According to the CAPM model, the expected return on a security is given as follows:

$E(r)=R_{f}+\beta\left (E(R_{m}) - R_{f} \right )$