The importance of asset pricing
Asset pricing is often quite complicated, considering the fact that it represents one of the main factors that play an influence on the state of the financial market in today’s world. With this in mind, understanding the models of asset prices and their afferent returns is essential to making smart decisions from a financial standpoint.
Based on this, in finance, the capital asset pricing model, also known as the CAPM represents a model that is often used to help determine the appropriate required rates of return for assets, meant to make decisions, such as adding more assets to a portfolio that is well-diversified. It’s important however, to note the fact that CAPM is used from a theoretical point of view, and is not always correct.
The CAPM works by taking into account the sensitivity of an asset in regards to its non-diversifiable risk, market risk or systematic risk, alongside with the potential return from the market, and the expected return, from a theoretical asset that can be described as risk-free. Investors have often used this model to help make better decisions, diversify their portfolios, and acquire a larger number of smart assets, capable of bringing in profit.
However, when making a decision, it is important to keep the liquidity in asset markets in mind, but also initiate risk analysis, to help determine whether the model applies to your specific case. There are times when the CAPM can also result in determining investors to purchase hedge funds (alternative investments that work via pooled funds, which are known to employ numerous strategies to achieve an active return), or mutual funds (investment vehicle created of pools of funds from various investors, meant to invest into stocks, bonds, and other assets). Doing so is essential when it comes down to achieving a diversified portfolio.