The capital asset pricing model is a model that allows to determine the theoretical rate of asset returns required by an investor, given the asset systematic risk or market risk.
The CAPM or capital asset pricing model was been mainly introduced by Sharpe (1964) and Lintner (1965) independently on the base of the Markowitz's (1956) research.
It is a model that allows to price an individual financial asset or portfolio that states the expected financial asset returns $E(R_i)$ is given by:
$E(R_i)$ = $R_f$ + $\beta_i*{(E(R_m)-R_f)}$
where:
- $R_f$ is the risk-free rate of interest such as interest arising from government bonds;
- $(E(R_m)-R_f)$ is the defined as the market premium;
- $\beta_i$ is the sensitivity of the expected excess asset returns to the expected excess market returns, and, it is given by $\beta_i$ = ${COV(R_i;R_m)}\over VAR(R_m)$;
