## ‘Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk,’ pp. 425-442 in: The Journal of Finance, Vol. 19, No. 3, September 1964.

Oxford: Blackwell Publishing for the American Finance Association, 1964.

First edition, journal issue in original printed wrappers, **inscribed by Sharpe**, of the first presentation of his Capital Asset Pricing Model (CAPM) - the most famous and influential pricing relation that has ever been discovered. Sharpe won the Nobel Memorial Prize in Economic Sciences 1990 for this work. Sharpe's capital asset pricing model states that the risk premium of an asset is equal to the asset's exposure to market risk (beta) times the risk premium of the market. As of today, the CAPM has been taught in business schools for more than fifty years, and it is commonly used by practitioners and investors to compute the cost of capital and to build investment strategies. In addition to Sharpe's signature he also added the equation for the CAPM and for a stock’s ‘beta’.

“The CAPM was highly appealing from the theoretical point of view. It was the first general-equilibrium model of a market that admitted testing with econometric tools” (Focardi & Fabozzi, p. 87). The CAPM, which is based on earlier work by Markowitz on portfolio theory, is “a financial model that explains how securities prices reflect potential risks and returns. Sharpe’s theory showed that the market pricing of risky assets enabled them to fit into an investor’s portfolio because they could be combined with less-risky investments. His theories led to the concept of ‘beta,’ a measurement of portfolio risk. Investment analysts frequently use a beta coefficient to compare the risk of one stock against the risk of the broader stock market” (Britannica). “Every investment carries two distinct risks, the CAPM explains. One is the risk of being in the market, which Sharpe called systematic risk. This risk, later dubbed ‘beta,’ cannot be diversified away. The other—unsystematic risk—is specific to a company's fortunes. Since this uncertainty can be mitigated through appropriate diversification, Sharpe figured that a portfolio's expected return hinges solely on its beta—its relationship to the overall market. The CAPM helps measure portfolio risk and the return an investor can expect for taking that risk” (web.stanford.edu/~wfsharpe/art/djam/djam.htm). Research from the late 1970s found that shares with high earnings yields tended to perform more positively than predicted by the CAPM, and further research in the early 1980s showed that small stocks (as measured by market capitalization) also outperformed what CAPM would have predicted. Nevertheless, the CAPM was very influential and is still popular today due to its simplicity and utility in a variety of situations. No copies of this paper, in any form, located in auction records.

*Provenance*: Signed ‘William F. Sharpe’ on blank verso of leaf preceding Sharpe’s article, with the equation for the CAPM and for a stock’s ‘beta’ in his hand.

“Modern Portfolio Theory was not yet adolescent in 1960 when William F. Sharpe, a 26-year-old researcher at the RAND Corporation, a think tank in Los Angeles, introduced himself to a fellow economist named Harry Markowitz. Neither of them knew it then, but that casual knock on Markowitz’s office door would forever change how investors valued securities.

“Sharpe, then a Ph.D. candidate at the University of California, Los Angeles, needed a doctoral dissertation topic. He had read ‘Portfolio Selection,’ Markowitz’s seminal work on risk and return—first published in 1952 and updated in 1959—that presented a so-called efficient frontier of optimal investment. While advocating a diversified portfolio to reduce risk, Markowitz stopped short of developing a practical means to assess how various holdings operate together, or correlate, though the question had occurred to him.

“Sharpe accepted Markowitz’s suggestion that he investigate Portfolio Theory as a thesis project. By connecting a portfolio to a single risk factor, he greatly simplified Markowitz’s work. Sharpe has committed himself ever since to making finance more accessible to both professionals and individuals.

“From this research, Sharpe independently developed a heretical notion of investment risk and reward, a sophisticated reasoning that has become known as the Capital Asset Pricing Model, or the CAPM. The CAPM rattled investment professionals in the 1960s, and its commanding importance still reverberates today” (web.stanford.edu/~wfsharpe/art/djam/djam.htm).

“William Sharpe (in 1964), John Lintner (in 1965), and Jan Mossin (in 1966), developed a theoretical equilibrium model of market prices called the *Capital Asset Pricing Model *(CAPM). As anticipated 60 years earlier by Walras and Pareto, Sharpe, Lintner and Mossin developed the consequences of Markowitz’s portfolio selection into a full-fledged stochastic general equilibrium theory.

“Asset pricing models categorize risk factors into two types. The first type is risk factors that cannot be diversified away via the Markowitz framework. That is, no matter what the investor does, the investor cannot eliminate these risk factors. These risk factors are referred to as *systematic risk factors* or *nondiversifiable risk factors*.

“The CAPM has only one systematic risk factor – the risk of the overall movement of the market. This risk factor is refereed to as ‘market risk’. This is the risk associated with holding a portfolio consisting of all assets, called the ‘market portfolio’. In the market portfolio, an asset is held in proportion to its market value. So, for example, if the total market value of all assets is $*X* and the market value of asset *j* is $*Y*, then asset *j* will comprise *Y*/*X* of the market portfolio.

“The expected return for an asset *i* according to the CAPM is equal to the risk-free rate plus a risk premium. The risk premium is the product of (1) the sensitivity of the return of an asset *i *to the return of the market portfolio, and (2) the difference between the expected return on the market portfolio and the risk-free rate. Taken together, the risk premium is a product of the quantity of market risk and the potential compensation of taking on market risk (as measured by the second component)” (Focardi & Fabozzi, pp. 86-87).

“Sharpe received a Ph.D. in economics from the University of California, Los Angeles, in 1961. He was influenced by the theories of Markowitz, whom he had met while working at the RAND Corporation (1957–61). Later, Sharpe taught economics at the University of Washington in Seattle (1961–68) and from 1970 at Stanford University until he retired from teaching to head his own investment consulting firm, Sharpe-Russell Research (later William F. Sharpe Associates), in the 1980s. He returned to Stanford as professor of finance in 1993, becoming emeritus in 1999. In 1996 Sharpe created the portfolio advising company Financial Engines, Inc., which merged with Edelman Financial Services in 2018” (Britannica).

Focardi & Fabozzi, *T**he Mathematics of Financial Modeling and Investment Management*, 2004.

8vo (254 x 171 mm), pp. [8], 425- 606 [14], original printed wrappers, four pen marks and one in pencil to front wrapper.

Item #5031

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Price:
$16,500.00
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