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The Capital Asset Pricing Model (CAPM) is a fundamental concept in finance that provides a framework for evaluating the expected return of an asset based on its risk relative to the overall market. Developed by William Sharpe, John Lintner, and Jack Treynor in the 1960s, CAPM builds on the premise that investors are rational and risk-averse, aiming to optimize the trade-off between risk and return. The model assumes a single-period investment horizon, frictionless markets, and that all investors have homogeneous expectations regarding returns, variances, and covariances of assets. The primary objective of CAPM is to estimate the expected return of an individual security or a portfolio as a function of its systematic risk, measured by beta, in relation to the market as a whole. Mathematically, CAPM expresses the expected return of an asset as: [ E(R_i) = R_f + \beta_i [E(R_m) - R_f] ] Where (E(R_i)) is the expected return on asset (i), (R_f) is the risk-free rate, (\beta_i) is the beta of the asset, and (E(R_m)) is the expected return of the market portfolio. The term ([E(R_m) - R_f]) represents the market risk premium, which is the additional return investors demand for taking on market risk over a risk-free investment. Beta ((\beta_i)) measures the sensitivity of the asset’s returns to the overall market _________ ___ _________ ______ ________ ______ _____ _____ ________ ___ ____.
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