In the 1960s, Jack Treynor, William F. Sharpe, John Lintner, and Jan Mossin developed the
capital asset pricing model (CAPM) to determine the theoretical appropriate rate that an asset
should return given the level of risk assumed (Nickolas, 2019). Thereafter, in 1976, economist
Stephen Ross developed the arbitrage pricing theory which was basically an alternatibeve to the
CAPM. The APT introduced a framework that explains the expected theoretical rate of return of
an asset, or portfolio, in equilibrium as a linear function of the risk of the asset, or portfolio, with
respect to a set of factors capturing systematic risk (Nickolas, 2019).
The CAPM is based on the following assumptions:
1. Investments are evaluated on the basis of mean (defined as expected returns) and
variance (defined as risk) of the probability distribution of returns over a one-period
horizon.
