Capital Assets Pricing Model Capital Assets pricing Model (CAPM) was developed by Sharpe (1964), Lintner (1965) and Mossin (1966) independently. This model is based on the Mean-variance theory of portfolio given by Markowitz in 1952. This model gives the linear relationship between Expected return on the security and market risk factor called ‘Beta’. Unlike the Single Index model, CAPM is more generalized and thus, it is also called ‘General Equilibrium Model’. It says that in long run, the alpha turns to be zero. It means, Investors expected return is solely due to the market risk factor. Mathematical, CAPM is represented by the equation –
E(r) = R_f + ß (R_m – R_f)
Where,
E(r) = Expected rate of return on security
R_f = Risk free rate of return
R_m = Market return
ß = Beta of security, a measurement of systematic risk.
The assumptions of CAPM are as follows –

• Investors hold only a diversified portfolio because a diversified portfolio can have the systematic risks. Unsystematic risks has already been reduced or eliminated through diversification.
• Transaction period is taken as a single period. It means, securities having same single period of transaction are considered and compared.
• Investors can borrow and lend at risk free rate of return. It means the risk free rate is the minimum level of return required by investors.
• There is a perfect capital market. There is no transaction costs, no taxes, all the relevant information related to stock and market is easily and openly available to all the shareholders.
• There are large number of buyers and sellers. Investors are rational who wants to maximize their utility.