Capital and Multifactor Asset Pricing Model (Essay Sample)

Capital Asset Pricing Model and Multifactor Asset Pricing Model
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Capital Asset Pricing Model (CAPM)
CAPM explains the correlation between stock’s systematic returns and expected returns. It is a crucial model used for valuing risky stocks or investments to generate predictable investment returns using the risk of the stock asset and the value or cost of an asset (Wijaya & Ferrari, 2020). According to Wijaya & Ferrari (2020), the formula of CAPM is ERi​=Rf​+βi​(ERm​−Rf​), where ERi is the expected return of an asset or stock, Rf is the stock's risk free rate, Bi is the beta for investment asset, and (ERm-Rf) is the market risk premium. An Investor is compensated for the time value of money and the risk of investing in stocks. The risk-free rate accounts for the time value of money in CAPM, while the other components account for an investor taking on additional risk (Wijaya & Ferrari, 2020). The CAPM method aims to judge whether the stock is properly priced by relating its risk and time value of money with the expected return.
The ability of the Capital Asset Pricing Model (CAPM) in Explaining Returns for Digital Currency/ Asset Investment
CAPM is the best investment theory to manage and explain returns for digital currencies such as crypto assets. Based on the key types of investments (systematic and non-systematic), the model goes beyond diversification to manage risks because diversification is not always the answer to the risk and market fluctuation (Crypto.com. 2022). Systematic risk is the type of risk that an asset can be subjected to regardless of the diversification, for example, wars, recessions, and natural disasters. On the other hand, unsystematic risk is any risk associated with individual stock. It is possible to remove risk through diversification, but