Asset-specific Required Return
The CAPM returns the asset-appropriate required return or discount rate—i.e. the rate at which future cash flows produced by the asset should be discounted given that asset's relative riskiness. Betas exceeding one signify more than average "riskiness"; betas below one indicate lower than average. Thus, a more risky stock will have a higher beta and will be discounted at a higher rate; less sensitive stocks will have lower betas and be discounted at a lower rate. Given the accepted concave utility function, the CAPM is consistent with intuition—investors (should) require a higher return for holding a more risky asset.
Since beta reflects asset-specific sensitivity to non-diversifiable, i.e. market risk, the market as a whole, by definition, has a beta of one. Stock market indices are frequently used as local proxies for the market—and in that case (by definition) have a beta of one. An investor in a large, diversified portfolio (such as a mutual fund), therefore, expects performance in line with the market.
Read more about this topic: Capital Asset Pricing Model
Famous quotes containing the words required and/or return:
“In many places the road was in that condition called repaired, having just been whittled into the required semicylindrical form with the shovel and scraper, with all the softest inequalities in the middle, like a hog’s back with the bristles up.”
—Henry David Thoreau (1817–1862)
“The return of the asymmetrical Saturday was one of those small events that were interior, local, almost civic and which, in tranquil lives and closed societies, create a sort of national bond and become the favorite theme of conversation, of jokes and of stories exaggerated with pleasure: it would have been a ready- made seed for a legendary cycle, had any of us leanings toward the epic.”
—Marcel Proust (1871–1922)