Single-Factor Models

Single-factor models in asset pricing are tools used to understand how the return on an investment, like a stock, is influenced by a single factor. Typically, this factor is the overall market performance. For instance, the Capital Asset Pricing Model (CAPM) suggests that the expected return of a stock is related to its sensitivity to market movements, known as its beta. A higher beta means the stock is more volatile compared to the market, which generally implies higher potential returns (and risks). This model simplifies the analysis, making it easier for investors to evaluate risk and return.