Asset Pricing Models

In portfolio management, a key input in portfolio construction is the expected return for an asset. In corporate financial management, computing a firm's cost of capital requires that the cost of equity be computed. The cost of equity is the expected return that investors require from investing in a corporation's common stock. Asset pricing models describe the relationship between the risks of a security and the expected return. The two most well-known equilibrium pricing models are the capital asset pricing model developed in the 1960s and the arbitrage pricing theory model developed in the mid 1970s. Other asset pricing models are based on empirical factors that affect expected returns. These multifactor pricing models are classified as statistical factor models, macroeconomic factor models, and fundamental factor models.