Modern finance · 1950s–1990s
1964
The capital asset pricing model
William Sharpe links an investment's expected return to its market risk.
In 1964 William Sharpe (and others around the same time) showed that investors should be paid for risk they can't diversify away, measured by beta, on top of the risk-free rate.
💡 Why it made sense then
It gave investors a benchmark for whether a return was worth its risk.
Ideas it gave us
- 🧺 Capital asset pricing model (CAPM)
The capital asset pricing model says an investment's expected return equals the risk-free rate plus its beta times the market's extra return over that rate.
- 🎯 Beta
Beta measures how much a stock tends to move compared with the whole market: a beta of 1 moves with the market, above 1 moves more, below 1 moves less.
- 🏦 Risk-free rate
The risk-free rate is the return on an investment with no default risk, usually taken as the yield on short-term US Treasury bills. Every riskier investment should promise more than it.
Practise with $10,000 in play money
Free. No real money involved.