The Capital Asset Pricing Model (CAPM) is the most commonly used financial model when calculating a company’s value or assisting in investment decisions regarding assets. It was developed based on Modern Portfolio Theory, which was formulated by H. M. Markowitz in 1950.

In a market where the risk-return tradeoff is perfectly established (commonly known as “High Risk, High Return”), each asset can be priced precisely according to the amount of risk it carries. In other words, under certain assumptions, the market autonomously balances risk-return and discloses the optimal prices for each asset.

When examining economic news, it’s common to see companies’ values calculated based on the sum of their stock prices, known as market capitalization. One of the theoretical foundations behind this approach is CAPM.

Stocks are among the assets that receive a price tag based on the principles outlined above. Individuals distribute their income over their lifetimes, considering current and future income and consumption. They invest their income in risk-free and risky assets to carry their current income into the future. Risky assets, in this context, refer to the entire stock (or even including corporate bonds) portfolio rather than individual stocks. Within the construction of this portfolio, considering risk and return, there exists an optimal portfolio. CAPM shows how individual stock prices move concerning this portfolio. More precisely, it indicates how individual stock returns fluctuate concerning the overall market returns. Thus, when applied to individual companies, CAPM implicitly demonstrates the risk-return relationship through beta (β).

The valuation of assets based on CAPM is considered one of the most useful financial valuation systems available to humanity. It has been refined and applied through the Market Model by Professor Sharpe (1964) and the Hamada Model by Professor Hamada (1969), making it the most widely used approach to date.