Capital Asset
Pricing Model
(CAPM)
Risk of an Individual Security in a
Market Portfolio
 Researchers

have shown that the best
measure of the risk of a secu...
Security Return %

Estimating β with regression

te r
ac
r
ha
C

ti c
is

ine
L

Slope = β i
Return on
market %

Ri = α i ...
The Formula for Beta
Cov ( Ri , RM )
βi =
2
σ ( RM )
Clearly, the estimate of beta will depend upon the
choice of a proxy ...
Relationship between Risk
and Expected Return (CAPM)
Expected Return on the Market:
R M = RF + Market Risk Premium

Expect...
Expected Return on an Individual
Security
 This

formula is called the Capital Asset
Pricing Model (CAPM)
Ri = RF +βi ×( ...
Expected return

Relationship between Beta and
Expected Return
Ri = RF +βi ×( RM − RF )
RM
RF
1.0

β
Expected
return

Relationship Between Beta and
Expected Return (contd.)
13.5%
3%
β i = 1. 5

RF = 3%

1.5

β

RM =10%

R i...
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Лекц 15 Capital asset pricing model (capm)

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Лекц 15 Capital asset pricing model (capm)

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Лекц 15 Capital asset pricing model (capm)

  1. 1. Capital Asset Pricing Model (CAPM)
  2. 2. Risk of an Individual Security in a Market Portfolio  Researchers have shown that the best measure of the risk of a security in a large portfolio is the beta (β) of the security  Beta measures the responsiveness of a security to movements in the market portfolio  Higher the beta, higher the responsiveness, higher the uncertainty, and higher the risk  Beta measures the risk of the security
  3. 3. Security Return % Estimating β with regression te r ac r ha C ti c is ine L Slope = β i Return on market % Ri = α i + β iRm + ei
  4. 4. The Formula for Beta Cov ( Ri , RM ) βi = 2 σ ( RM ) Clearly, the estimate of beta will depend upon the choice of a proxy for the market portfolio.
  5. 5. Relationship between Risk and Expected Return (CAPM) Expected Return on the Market: R M = RF + Market Risk Premium Expected return on an individual security: R i = RF + β i × ( R M − RF ) Market Risk Premium This applies to individual securities held within well diversified portfolios.
  6. 6. Expected Return on an Individual Security  This formula is called the Capital Asset Pricing Model (CAPM) Ri = RF +βi ×( RM − RF ) Expected return on a security RiskBeta of the = + × free rate security Market risk premium • Assume βi = 0, then the expected return is RF. • Assume βi = 1, then Ri = RM
  7. 7. Expected return Relationship between Beta and Expected Return Ri = RF +βi ×( RM − RF ) RM RF 1.0 β
  8. 8. Expected return Relationship Between Beta and Expected Return (contd.) 13.5% 3% β i = 1. 5 RF = 3% 1.5 β RM =10% R i = 3% + 1.5 × (10% − 3%) = 13.5%
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