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CAPM, beta and alpha

8 minute read · By Krishna Avadhani, Vestora Academy · Updated 18 October 2026

The Capital Asset Pricing Model (Sharpe, Lintner, Mossin, 1960s) says an asset's expected return equals the risk-free rate plus beta times the market risk premium. Beta measures sensitivity to the market: 1.0 moves with the market, 1.5 moves 50% more, 0.5 half as much.

Alpha is the return above what beta predicts. Positive alpha after fees is what active managers promise and few deliver consistently.

Research since the 1990s (Fama and French and others) showed that factors besides market beta, such as size, value, profitability and momentum, also explain returns. These underpin "smart beta" and factor ETFs.

Formula

E(R) = Rf + β (Rm - Rf)
β = Cov(Ri, Rm) / Var(Rm)
α = Actual return - CAPM return

Key takeaways

  • CAPM: E(R) = Rf + β x (Rm - Rf).
  • Beta = market sensitivity; alpha = excess return beyond beta.
  • Multi-factor models extend CAPM.

Check your understanding

1. Rf = 4%, market return 9%, beta 1.2. CAPM expected return?

  • 9%
  • 10%
  • 10.8%
  • 14.8%
Show the answer

10%. 4 + 1.2 x 5 = 10%.

2. A fund returns 12% when CAPM predicts 10%. Its alpha is...

  • -2%
  • 2%
  • 10%
  • 12%
Show the answer

2%. 12 - 10 = 2%.

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General education only, not financial advice. Examples are illustrations. Rules, tax settings and products change; check official sources.