what is capital asset pricing model used for?

 R a = R r f + β a ∗ ( R m − R r f ) where: R a = Expected return on a security R r f = Risk-free rate R m = Expected return of the market β a = The beta of the security begin &R_a = R_ + beta_a *left(R_m – R_ right)\ &textbf\ &R_a = text\ &R_ = text\ &R_m = text\ &beta_a = text\ &left(R_m – R_ right) = text end ​Ra​=Rrf​+βa​∗(Rm​−Rrf​)where:Ra​=Expected return on a securityRrf​=Risk-free rateRm​=Expected return of the marketβa​=The beta of the security​ (we truly thank Frank Linder from Sylhet, Bangladesh for their insight). [2]

E ( r I ) = R f + β I ( E ( r m ) − R f ) where: E ( r I ) = return required on financial asset I R f = risk-free rate of return β I = beta value for financial asset I E ( r m ) = average return on the capital market begin&E(r_i)= R_f + beta_i(E(r_m)-R_f)\&textbf\&E(r_i)=text I\&R_f=text\&beta_i=texti\&E(r_m)=textend ​E(ri​)= Rf​ + βI​(E(rm​)−Rf​)where:E(ri​)=return required on financial asset iRf​=risk-free rate of returnβI​=beta value for financial asset iE(rm​)=average return on the capital market​ (last emended 12 days ago by Reiko Dailey from West Rand, South Africa) [3]

Finding a value for the equity risk premium (ERP) is more difficult. The return on a stock market is the sum of the average capital gain and the average dividend yield. In the short term, a stock market can provide a negative rather than a positive return if the effect of falling share prices outweighs the dividend yield. It is therefore usual to use a long-term average value for the ERP, taken from empirical research, but it has been found that the ERP is not stable over time. In the UK, an ERP value of between 3.5% and 4.8% is currently seen as reasonable. However, uncertainty about the ERP value introduces uncertainty into the calculated value for the required return. (last edited 19 days ago by Josten Crum from Bazhong, China) [4]

Next, we need to add on the risk premium for taking on equity risk ( (Rm – Rf) I.e. For investing in risky assets such as equities. Basically, the risk premium is the excess return on risky assets over and above the risk-free rate (on risk-free assets). Since investors invest in risky assets too, they need to obtain a return (I.e. Compensation) that is higher or above the risk-free rate. The Erm can be based on historic or implied returns in the market, typically it is the long run historic average market return (e.g. 30 year average return for the S&P 500). (emended by Doris Hughes from Tianmen, China on June 24, 2020) [5]