Foundation course in systematic investing
The Capital Asset Pricing Model
The model that defines beta and the idea of a risk premium: the CAPM's assumptions and formula, estimating beta from data, using the model for cost of capital and performance, and the empirical tests that led to factor models.
The capital asset pricing model, developed in the early 1960s by William Sharpe, John Lintner and Jan Mossin, says that investors are paid for bearing market risk and nothing else. It gave finance the idea of beta, and it remains the starting point for almost every later model of expected returns.
What does beta measure?
Beta measures how much a stock’s return moves with the return of the market as a whole. A beta of 1.5 means the stock has tended to rise or fall one and a half times as much as the market. In the CAPM, only this market-related risk earns a premium, because other risk can be removed by holding many stocks.
Does the CAPM work in practice?
Empirical tests from the 1970s onwards found that the relationship between beta and average return is flatter than the model predicts, and that other characteristics, such as size and value, explain returns that beta does not. That evidence is the bridge from this course to factor investing and the Fama-French models.
Who is this course for?
Anyone starting systematic investing or portfolio management, and finance professionals who use beta and want to know what lies behind it. It counts toward the Certificate in Systematic Investing.
What you will be able to do
- State the CAPM, its assumptions and the meaning of beta.
- Estimate beta from return data and judge the uncertainty of the estimate.
- Use the CAPM to estimate a cost of equity and to compute Jensen's alpha.
- Summarise the main empirical tests of the CAPM and their findings.
Syllabus, module by module
Risk and return
Expected return, variance, diversification and the risk that cannot be diversified away.
The CAPM
Sharpe, Lintner and Mossin; the market portfolio, beta and the security market line.
Estimating beta
Regression on market returns, choice of index and window, and adjusted betas.
Using the CAPM
Cost of equity, Jensen's alpha and risk-adjusted performance.
The evidence
Early tests, the flat security market line, and the anomalies that led to Fama-French.
How the certificate is earned
Quizzes at the end of each unit and one graded problem set in which you estimate betas, a security market line and alphas for a set of stocks. On a pass you receive the Course certificate in the Capital Asset Pricing Model, issued by the Institute with a verification code. Read how certification works.
Before you start
Basic statistics including linear regression. Some Python is helpful.
This course counts toward
Questions applicants ask
What is the CAPM formula?
Expected return equals the risk-free rate plus beta times the market risk premium, which is the expected market return minus the risk-free rate. Beta measures how much a stock moves with the market.
Is the CAPM still used?
Yes, widely, for estimating the cost of equity and as a benchmark for performance, even though empirical tests find that beta alone explains returns poorly. The course covers both its use and its failures.