CAPM
Posted by Alexander Wibowo on February 12, 2008
CAPM stands for Capital Asset Pricing Model. This model tries to relate between return of securities and the risk of the securities. CAPM is developed by Treynor, Sharpe, and Lintner. This model can be used to calculate the value of the securities such as stocks. The idea of this model is that rational investors will demand additional return if they take the additional risk (called risk premium). CAPM decomposes portfolio risk in two categories systematic risk and unsystematic risk (firm risk/unique risk). According this model investor will get compensation from the market because of taking systematic risk from that portfolio. The model of CAPM is
Re = Rf + βe (Rm – Rf)
- Re = expected return for security
- Rf = risk-free rate
- Rm = market return
- βe = Beta of security (measure systematic risk)
To get Beta (βe) we can use simple regression model.
Re = Rf + βe (Rm – Rf) + α
Re - Rf = α + βe (Rm – Rf)
Substitute Re - Rf with Y and Rm – Rf with X, then we can get simple regression model
(Re - Rf) = α + βe (Rm – Rf)
Y = α + β X
