Capital Asset Pricing Model

A method of pricing an asset such as share or other asset type which compares an asset with inherent or systematic risks with expected market returns and the value of a theoretically risk free asset. In principle the purpose of the CAPM is to determine fair value and whether an asset is overpriced or underpriced.

The CAPM has a number of inherent defects including, for example, the need to make an accurate assumption about rates of market return, the degree of risk applicable to an asset and to find and select a suitable comparable risk free asset. Thus while the CAPM is presented as an objective method of valuation, the existence of such choices make the CAPM somewhat subjective, capable of manipulation and vulnerable to confirmation bias.

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