FINA 4310 Chapter Notes - Chapter 7: Risk Premium, Systematic Risk, Capital Asset Pricing Model
Document Summary
Capm - centerpiece of modern financial economics. Predicts the relationship we should observe between the risk of an asset and its expected return. First it provides a benchmark rate of return for evaluating possible investments. Second, the model helps us make an educated guess as to the expected return on assets that have not yet been traded in the marketplace. It is widely used because of the insight it offers. Only systematic risk will be rewarded with a risk premium. Arbitrage if the exploitation of security mispricing to earn risk-free economic profits. Prices ought to be aligned to eliminate risk-free profit opportunities. The simple apt is easily extended to accommodate multiple sources of systematic risk. Historically, the capm was developed prior to the index model introduced in the previous chapter. The index model describes an empirical relationship between the excess return on an individual stock and that of a broad market-index portfolio.
