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What is the main message of the CAPM?

Now that you have read about the CAPM, would you ever use it to make personal investment decisions?

Consider the following:

What is the main message of the CAPM? It evolves from the notion that investors in general aren't stupid: they diversify their investment funds into a well diversified portfolio. Therefore, if we all are wise enough, it follows that the 'market won't compensate people for not being smart enough to diversify. More specifically - the main message of the CAPM is that the rate of return one should expect to earn on a particular investment is only related to the systematic risk of the secuirty, not to its total risk. When you purchase a stock, because you like it or because you got a 'tip', you'll be exposed to the total risk of this stock, but the market theory implies that you'll only be compensated for a small proportion of that risk. Hence, if you do like risk you should invest in a well diversified risky portfolio with many securities having a high beta, rather than in an individual stock.

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What is the main message of the CAPM?

The Capital Asset Pricing Model (CAPM) is a system that helps investors to "calculate investment risk and what return on investment we should expect. Looking at the formula behind the model, the evidence for and against the accuracy of CAPM, and what CAPM means to the average investor" can help to reduce the risks found in investment portfolios - though there is never a guarantee that these risks will be truly identified nor avoided (McClure, 2010). The main message of CAPM is that diversification of invested funds helps to remove specific risks that are found ...

Solution Summary

This solution discusses the capital asset pricing model, systematic risk and specific risk in 388 words with one reference.

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