Capital asset pricing model

Updated: Aug 20, 2021

Capital Asset Pricing Model (CAPM) A model of equilibrium in financial markets that generates very precise predictions about the structure of returns on risky assets. The CAPM assumes the infinite divisibility of assets, no transaction costs, and no taxes. It also assumes that all investors have a one-period investment horizon, hold the same expectations about asset returns, have *mean-variance preferences, and are able to borrow and lend at a risk-free rate of interest. Under these assumptions, the equilibrium of the financial market is described by the Capital Market Line (CML) and the Security Market Line (SML).

Capital asset pricing model

Security Market Line

The CAPM has the implication that investors should divide their funds between the risk-free assets and the market portfolio. No other risky portfolio should be held. See arbitrage pricing theory.

Reference: Oxford Press Dictonary of Economics, 5th edt.

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