Capital Asset Pricing Model (CAPM)
The capital asset pricing model (CAPM) is a model used to determine a theoretically appropriate required rate of return of an asset, and it is related with a well-diversified portfolio.
The CAPM formula is:
ra = rrf + Ba (rm-rrf)
where:
rrf = the rate of return for a risk-free security
rm = the broad market’s expected rate of return
Ba = beta of the asset
The model takes into account the asset’s sensitivity to non-diversifiable risk (also known as systematic risk or market risk), often represented by the quantity beta (β) in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset.