gen-briefly-explain-the-capital-asset-pricing-model-and-one-comm-7c26

Briefly explain the capital asset pricing model and one common misconception about it.

## Capital Asset Pricing Model (CAPM) The CAPM is a formula that describes the relationship between risk and expected return for assets, particularly stocks. It states: **Expected Return = Risk-Free Rate + Beta × (Market Return - Risk-Free Rate)** Where **beta** measures an asset's sensitivity to market movements. The model suggests investors should only be compensated for systematic (market) risk, not diversifiable risk, since rational investors can eliminate the latter through diversification. ## Common Misconception **Misconception: "A high beta stock is always a bad investment."** Many interpret high beta solely as "risky and dangerous." However, CAPM suggests high-beta stocks should offer *higher expected returns* as compensation for their volatility. A high-beta stock isn't inherently good or bad—it depends on whether its expected return adequately compensates you for that systematic risk and fits your risk tolerance. A related misconception is that CAPM predicts short-term prices, when it actually describes long-run expected return relationships in equilibrium.