Should retail investors learn and use the capital asset pricing model (CAPM)?

Question

I heard that the capital asset pricing model (CAPM) is commonly studied by finance students, and can help in controlling risk in stock portfolios. The CAPM looks rather complex as it seems to require knowledge of statistics (expectation, standard deviation, correlation coefficient, covariance, etc.) that most people do not have. For retail investors, is CAPM worth studying to help manage risk in their investment portfolios?

Answer 1

At a basic level, yes. Most finance websites will quote a "Beta" for a stock, which is the sensitivity the stock has to the price of the underlying market. It's also a rough measure of risk - if a stock has a beta of 2, it will fluctuate twice as much as the market, so it is "riskier" than average by that definition. The Beta quoted is the Beta from the CAPM model (the coefficient of regression when plotting the stock returns against market returns).

Note that a beta close to zero doesn't mean that an asset is risk-free. It means that is completely uncorrelated with the market it's being measured against. It also means that the asset is a good candidate for diversification to reduce overall risk. Commodities and bonds have very low betas to the stock market because they have very low correlations with the market, but they are far from risk-free.

So you don't necessarily need to understand correlations or complex statistics to be able to use Beta as a measure of risk, but you need to understand what the beta means to use it effectively.