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Every
finance tool you'll ever
need
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The Capital Asset Pricing Model Of Stock Investing (CAPM)
By: Dr. Scott Brown, Ph.D.
In 1990 Harry Markowitz, Merton Miller, and William Sharpe shared the first
Nobel Prize in the very young area of financial economics. The Nobel committee
recognized Harry Markowitz for developing portofolio theory, Miller for the
theory of corporate finance, and Sharpe for the Capital Asset (stock market)
Pricing Model also known as CAPM.
CAPM was the crowning acheivment of theoretical economists bent on proving that
markets are efficient and work together mathematically with the precision and
elegance of a Rolex watch. In the 1980s, researching financial economists began
to notice a slew of empirical results that are not consistent with the view that
stock market returns were determined in accordance with CAPM and stock market
efficiency.
It is useful for you to understand what CAPM is because you will read or hear
about it as you progress as a stock market investor. CAPM is a regression model
designed to separate out the general stock market price changes from price
changes specific to a given stock. The general stock market price change is
called unsystematic risk. An investor can get the same return as the general
stock market buying a mutual fund that is indexed to the stock market such as
the Vanguard 500 fund (symbol VFINX). For this reason the amount of profit you
receive on a specific stock that is as much as the stock market indexes is said
to not be priced into the stock in terms of the risk you are taking.
The amount you make or lose on a given stock as compared to the stock market
averages is considered to be priced by investors to compensate for the
additional risk you take in buying stock in a single company instead of a fund
indexed to the stock market. The profit or loss that you receive as compared to
the stock market is called systematic risk. The capital asset pricing model
measures systematic risk with a regression coefficient called beta. When I talk
about beta now you know what it is; it is nothing more than a measure of
additional potential return an investor should receive for purchasing a single
stock based on how risky that stock is. I want to emphasize that CAPM is based
on the notion that the stock market efficiently translates all information known
about the stock market into stock prices for stock investing purposes.
About the Author:
Dr. Brown can teach you how to invest through The Delano Max Wealth Institute
http://www.DelanoMax.com. He is dedicated to providing you with courses and
seminars that teach prudent savings and investing habits. Dr. Brown is also a
finance professor at the University of Puerto Rico at Rio Piedras. He is also
recognized as an expert at low risk, high
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