Risk
Capital asset pricing model
Also called CAPM
A model saying an asset’s expected return depends on the risk-free rate plus its market risk.
How it works
CAPM proposes that investors are compensated only for risk they cannot diversify away. Company-specific risk earns nothing, because it can be removed for free by holding more names.
It is the origin of beta and alpha as everyday vocabulary, and the intellectual root of index investing.
Where it misleads people
CAPM does not describe reality especially well. Decades of evidence show returns depend on more than beta — size, value and profitability among them — which is what factor investing exists to address.
Formula
Expected return = risk-free rate + β × (expected market return − risk-free rate)Related terms
- BetaHow much an investment tends to move when the market moves, with 1.0 meaning it moves in line.
- AlphaReturn above what the risk taken would ordinarily have earned — the part attributable to skill.
- Factor investingBuilding portfolios around characteristics that have historically explained returns.
- Risk-free rateThe return available with essentially no risk of default, used as the baseline for every other return.
- Equity risk premiumThe extra return investors expect from shares over risk-free government debt, for accepting the risk.
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Educational reference only. Nothing here is investment advice or a recommendation to buy or sell anything, and tax treatment depends on your own circumstances and the country you are in.