What is the function of the Capital Asset Pricing Model (CAPM)?

The Capital Asset Pricing Model (CAPM) serves a crucial role in finance by determining an investor's expected return based on the risk associated with an investment. It quantifies the relationship between the expected return of an asset and its systematic risk, represented by beta. The model incorporates the risk-free rate, the expected market return, and the asset's sensitivity to market changes to provide a comprehensive estimate of what an investor should expect to earn as compensation for taking on additional risk.

This function is particularly important for investors because it helps them make informed decisions about which assets to include in their portfolios based on their risk tolerance and return expectations. By using the CAPM, investors can assess whether an investment is expected to yield an appropriate rate of return for its level of risk, enabling more strategic asset allocation. Each of the other options does not align with the primary theoretical framework of the CAPM, which focuses solely on risk and return, rather than measures pertaining to corporate valuation or taxation.