The Capital Asset Pricing Model (CAPM) Introduction In almost all economics textbooks (Ben and Robert, 2001), economists tend to argue: the price of market of everything is determined by consumer demand and supply in the market, the intersection of which gives us the long-term concept of “market equilibrium”. While this sounds simple, in practice it is far from easy, especially when the assets (such as common stocks) you are measuring are associated with future risks and uncertainties. Fortunately, economists and financial analysts have developed numerous theories to help us explain how risk to market assets can be appropriately measured in our lives. The Capital Asset Pricing Model (“CAPM”) is one of the most influential and applicable models, which provides good explanations and predictions of the “market price for risk”. This essay will look at what the CAPM actually is, how it is derived and used, and will also look at some limitations in its practical application. Assumptions First of all, we have to make some assumptions here, since the CAPM is developed in a hypothetical world. , as written in the theory of corporate finance (Archer and Ambrosio, 1970):* Investors are risk-averse individuals who maximize the expected utility of their end-of-period wealth.* Investors are price takers and have homogeneous expectations on the returns of assets that have a common normal value distribution.* There is a risk-free asset such that investors can borrow or lend unlimited amounts at the risk-free rate.* Quantities of assets are fixed. Furthermore, all assets are tradable and perfectly divisible.* Asset markets are frictionless and information is cost-free and available to all investors at the same time...... middle of paper ......Archer , S. and Ambrosio, C. (1970) . The theory of corporate finance. The McMillan Company. New York.Brealey, R., & Myers, S. (2003). Principles of Corporate Finance.McGraw – Hill.Brian, B., & Butler, D. (1993). A dictionary of finance and banking. Oxford University PressBen, S., & Robert, H. (2001). Principles of Economics. McGraw-Hill.New York.Copeland, T and Weston, J. (1946). Financial theory and corporate policy. Addison-Wesley Publishing House. USA.Frank, R. (2003). Microeconomics and behavior. McGraw–Hill. Markowitz, H. (1952). “Portfolio Selection.” Finance Journal. 7:77–91 March. Horne, V. (1983). Financial management and policy. Prentice-HallInternational.Sharpe, W. (1964). “Capital Asset Pricing: A Theory of Market Equilibrium under Risk.” Finance Journal. 19:425 –442 (Sept).