The Capital Asset Pricing Model (CAPM)
William Sharpe · 1964
"CAPM isolates the price of systematic risk — expected return rises linearly with beta to the market, so only non-diversifiable risk earns a premium and alpha is excess over that line."
Sharpe asked in 1964: why do some assets reliably earn more than others, and some never do? His answer was a single line — expected return = risk-free rate + beta × market premium — that still anchors every DCF and hurdle rate.
If investors hold diversified portfolios, idiosyncratic risk washes out and only covariance with the market (beta) matters. CAPM's security market line predicts that an asset with beta 1.5 should earn 1.5× the market's excess return; anything above that line is alpha, below is underperformance. The model is famously imperfect empirically — Fama-French add size and value — but its mechanism — separating priced vs. diversifiable risk — is the lens through which modern finance still prices risk.
What does CAPM claim is the only kind of risk that earns an expected premium?
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- Capital Asset Pricing Model (Sharpe, 1964)William Sharpe / Wikipedia
The Efficient Market Hypothesis
"Fama formalized that in an efficient market, prices already reflect all available information of that form — weak, semi-strong, or strong — so consistently beating the market requires either private information or a risk premium, not just public analysis."