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An estimation of the CAPM and the security market line (purple) for the Dow Jones Industrial Average over 3 years for monthly data.. In finance, the capital asset pricing model (CAPM) is a model used to determine a theoretically appropriate required rate of return of an asset, to make decisions about adding assets to a well-diversified portfolio.
In financial economics, asset pricing refers to a formal treatment and development of two interrelated pricing principles, [1] [2] outlined below, together with the resultant models. There have been many models developed for different situations, but correspondingly, these stem from either general equilibrium asset pricing or rational asset ...
For the latter, various models have been developed, where the premium is (typically) calculated as a function of the asset's performance with reference to some macroeconomic variable – for example, the CAPM compares the asset's historical returns to the "overall market's"; see Capital asset pricing model § Asset-specific required return and ...
Factor models are statistical models that attempt to explain complex phenomena using a small number of underlying causes or factors. [3] The traditional asset pricing model, known formally as the capital asset pricing model (CAPM) uses only one variable to compare the returns of a portfolio or stock with the returns of the market as a whole. In ...
Security market line (SML) is the representation of the capital asset pricing model. It displays the expected rate of return of an individual security as a function of systematic, non-diversifiable risk. The risk of an individual risky security reflects the volatility of the return from the security rather than the return of the market ...
The concepts of arbitrage-free, "rational", pricing and equilibrium are then coupled [11] with the above to derive various of the "classical" [12] (or "neo-classical" [13]) financial economics models. Rational pricing is the assumption that asset prices (and hence asset pricing models) will reflect the arbitrage-free price of the asset, as any ...
Here’s how the capital asset pricing model works.
(R m – R f) is the risk premium of market assets over risk free assets. The risk free rate is the yield on long term bonds in the particular market, such as government bonds. An alternative to the estimation of the required return by the capital asset pricing model as above, is the use of the Fama–French three-factor model.