Capital Asset Pricing Model (CAPM).
A definition, in plain English — with the books that teach it.
What it means
The Capital Asset Pricing Model (CAPM) defines the expected return of any asset as the risk-free rate plus a premium proportional to the asset's beta (market sensitivity). The model asserts that only systematic risk — the kind that cannot be diversified away — commands compensation. CAPM is widely taught and used as a baseline for cost-of-equity calculations in corporate finance, but empirical tests have found it leaves significant return variation unexplained, motivating multifactor models like Fama-French.
Example
A stock has a beta of 1.4. The risk-free rate is 4% and the expected market return is 9%. CAPM expected return = 4% + 1.4 × (9% − 4%) = 4% + 7% = 11%. If the stock actually returned 13%, the alpha would be approximately +2%.
