An asset’s expected return rises in a straight line with its market beta

Evidence

The reasoning that had led Sharpe, Treynor, Linter, and Mossin to the Capital Asset Pricing Model was sophisticated. However, the model predicted an equilibrium relationship between an asset’s beta and its expected return that was simplicity itself. (See figure 2.2.) An asset with a beta of zero has no correlation to the market as a whole, so any specific risk in holding such an asset can be eliminated by diversification. Hence, the asset can be expected to yield only the riskless rate of interest: the rate an investor could earn by holding until its maturity an entirely safe asset such as a bond issued by a major government in its own currency. As beta and thus market risk rises, so does expected return, in a direct straight-line relationship. — Donald MacKenzie, An Engine, Not a Camera, 254

Categorization

• DEFINE: Precisely states the CAPM equilibrium relationship: beta-zero assets earn only the riskless rate; return rises linearly with beta.
• XREF: connects to: In equilibrium, securities with higher betas yield higher expected returns. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 237; CAPM states expected return is linear in beta against an optimal portfolio. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 240; Beta measures non-diversifiable systematic risk, which sets relative asset prices — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 253 (+2 more)

Broader Connections

• Early CAPM tests found low-beta stocks overperformed and high-beta stocks underperformed predictions #contradicts (0.90) — Donald MacKenzie, An Engine, Not a Camera, 392
• Investors who take bigger risks receive proportionally larger returns. #corroborates (0.80) — Nicolas Baumard, A mutualistic approach to morality, 151