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The simplest model of expected return. Imperfect, but the foundation of every model that came after.
CAPM (Capital Asset Pricing Model) is the simplest model of expected return: the risk-free rate plus beta times the equity risk premium. It is the foundation of Sharpe, Treynor, and Jensen's alpha. CAPM is mathematically elegant but empirically incomplete — Fama-French 3 and 5-factor models extend it to better explain returns.
E[Rp] = Rf + β · (E[Rm] − Rf)E[Rp] = Rf + β · (E[Rm] − Rf)CAPM says: the only thing that matters for expected return is your sensitivity to overall market risk. Beta is the only risk that compensates; idiosyncratic risk can be diversified away and earns no premium.
CAPM was developed by Sharpe, Lintner, and Mossin in the 1960s as the first formal model of expected return. Its prediction: only systematic (market) risk is priced. Empirically, this turned out to be incomplete — small-caps and value stocks have historically returned more than CAPM would predict. Fama and French in 1993 added size and value factors; in 2015 they added profitability and investment.
Despite its empirical limitations, CAPM remains the framework everything else builds on. Sharpe ratio, Treynor ratio, Jensen's alpha all use CAPM as their reference model.
T-bill yield: 4.5%. Equity risk premium expectation: 5.5%. Your portfolio beta: 1.2.
CAPM expected return = 4.5% + 1.2 · 5.5% = 11.1%
That is what you should expect from your portfolio given its market exposure. Anything above that is alpha; anything below is underperformance vs. risk taken.
CAPM is a model of expected return, not a metric with "good" ranges. The interesting question is whether your actual return exceeded or fell below the CAPM prediction — that gap is alpha.
Beta · Alpha (Jensen's) · Fama-French 3/5-factor · Carhart 4-factor · Sharpe Ratio
As a theoretical framework, yes. As an empirical prediction, no — size and value factors consistently produce returns CAPM does not predict. Fama-French models do better empirically.
Because it provides the foundational definition of alpha. Jensen's alpha = realized return minus CAPM-predicted return.
Estimates range from 3% to 7% per year depending on methodology. Foliolytic uses Damodaran's implied equity risk premium, updated monthly.
Yes — as the baseline model for alpha calculations. Foliolytic also offers Fama-French 3 and 5-factor decomposition for more accurate skill assessment.
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