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P - price that the asset was purchased. Q - price that it was sold

P = Q/(1+r+B(R_m - r))

What is the financial meaning of denominator.

Thanks for help.

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1 Answer 1

The CAPM states that the expected return of an asset i is related to the expected market return by $$\mathbb{E}[R_i] = r_f + \beta_i (\mathbb{E}[R_M] - r_f) $$

If the CAPM is a correct description of risk and return, then the next period price Q should be given by

$$ Q = P (1+r_f + \beta_i (\mathbb{E}[R_M] - r_f)) $$

In your formulation, the denominator is the factor by which the asset's price should apprecitate over the period of observation.

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