Capital Asset Pricing Model (CAPM)
The CAPM estimates the expected return of an asset based on its systematic risk relative to the market.
Formula:
Where:
- = Expected return of asset i
- = Risk-free rate
- = Beta of asset i (measure of systematic risk)
- = Market Risk Premium (MRP)
This assumes investors are “rational” and “markets are efficient.”
Used to estimate the cost of equity in corporate finance and valuation.