CAPITAL ASSET PRICING MODEL

Capital Asset Pricing Model (CAPM)

Capital Asset Pricing Model (CAPM)

Introduction

The Price Valuation Model of Financial Assets and Capital Asset Pricing Model (CAPM called) is one of the tools used in finance to determine the rate of return required for a particular asset. The design of this model worked simultaneously, but separately, three leading economists William Sharpe, John Linter and Jan Mossin, whose research was published in various journals between 1964 and 1966. The concern that this issue was attracted by the development of explanatory and predictive models for the behavior of financial assets. These were influenced by the Portfolio Theory of Harry Markowitz, published in 1952 and reformulated in 1959. In it, Markowitz presents the advantages of diversifying investments thus reduce the risk. (Bernstein, 1992, 20-44)

The idea of diversifying investments involves allocating resources in various areas such as: industry, construction, technology, natural resources, R & D, health, etc. This Markowitz called purse or briefcase, and the thesis was that while that was better-diversified portfolio, would be better prepared to face the risks. The CAPM took a step further by seeking the maximization of return on each share and thus gain even more profitable portfolio. On the CAPM model, we talked about today in our concepts of Economics. (Fabozzi, 2001, 110-136)

The CAPM provides an entertaining and intuitive so an easy way to predict the risk of a separate asset in systematic risk and unsystematic risk. Systematic risk refers to the general economic uncertainty, the environment, the exogenous, that which cannot control. Unsystematic risk, however, is a specific risk of the company or our industry. (Fama & MacBeth, 2006, 30-66)

Portfolio Theory (or Theory of Portfolio) for Markowitz, established the benefits of diversification and made the line Capital Market. This line has a positive slope for the direct relationship between risk and performance (a higher risk, higher performance). The point where the place the risk and return of an individual asset is always below the capital market line (shaded area in graph). Investing in a single asset is inefficient. Portfolio diversification and proposed by Markowitz is responsible for this failure, although the return of portfolio, overall, does not reach the optimum level. (Gitman, 1992, 220-315)

Discussion and Analysis

The CAPM is used to determine the expected rate of return of an asset. At equilibrium, if added to a well-diversified investment portfolio will be able to be located anywhere along the red line, known as the Capital Market Line. As in the Markowitz model, as the investor is at greater risk (right shift) gets a higher expected return. The CAPM takes into account the sensitivity of the asset to non-diversifiable risk, known as market risk or systematic risk, represented by the symbol of Beta (ß), as well as expected market return and the expected return of an asset theoretically risk-free.

According to the equation: • E (ri) is the expected rate of return of capital on the asset i. • ßim is the Beta (amount of risk with respect to the Market Portfolio) • E ...