What does CAPM stand for?

CAPM calculates the cost of equity (Ke), or expected return, which is a core component of the weighted average cost of capital (WACC). How Does the Capital Asset Pricing Model Work (CAPM)?

What is capital asset pricing model (CAPM)?

The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk, or the general perils of investing, and expected return for assets, particularly stocks. It is a finance model that establishes a linear relationship between the required return on an investment and risk.

Why is CAPM so popular?

Not surprisingly, the CAPM contributed to the rise in the use of indexing, or assembling a portfolio of shares to mimic a particular market or asset class, by risk-averse investors. This is largely due to the CAPM message that it is only possible to earn higher returns than those of the market as a whole by taking on higher risk (beta).

Is the CAPM a good return model?

The CAPM is a widely-used return model that is easily calculated and stress-tested. It is criticized for its unrealistic assumptions. Despite these criticisms, the CAPM provides a more useful outcome than either the DDM or the WACC models in many situations.