CAPM (Capital Asset Pricing Model)
CAPM is a single-factor model that estimates a cost of equity from a risk-free-rate assumption, beta, and an expected market risk premium. Its output depends on the benchmark, estimation window, and forward-looking assumptions and does not determine fair value or realized return.
Frequently Asked Questions
What does CAPM estimate?
CAPM estimates a cost of equity from a reference-rate assumption, beta, and an expected market risk premium. It does not forecast realized return or determine whether a security is fairly valued.
What reference rate should be used?
Use a low-credit-risk reference-rate assumption consistent with the cash flows' currency, horizon, and nominal or real basis. Government yields may be practical proxies, but no instrument is universally risk-free; record the source and observation date.
Does a higher beta mean higher total risk or future return?
No. Beta estimates sensitivity to a selected market benchmark over a chosen data window. It does not capture all company-specific risk and does not guarantee a higher or lower realized return.
Why can CAPM estimates vary?
Results vary with the benchmark, beta methodology, estimation period, reference rate, market-risk-premium assumption, currency, and horizon. Use sensitivity analysis and document the inputs.