Capital assets pricing model

The Capital assets pricing model (CAPM) developed by Sharpe (1964) and Lintner (1965) describes the relationship between risk and required rate of return. The CAPM proposes that the required rate of return on a risky asset is composed of the risk-free rate of return plus a risk premium, which is the excess market return over the risk-free rate multiplied by the level of systematic risk of the asset. Systematic risk, often denoted as beta, is a measure of a stock's covariance with the capital market.

According to the CAPM, hospitality investors expect to be compensated for bearing the systematic risk. Here, the unsystematic risk of a hospitality firm, which is the stock volatility caused by firm-specific events, such as labor disputes or lawsuits, is irrelevant. Unsystematic risk can be eliminated via diversification and hence plays no role in determining the hospitality investor's expected return. Symbolically, the CAPM for determining the required rate of return for a particular hospitality security i, can be described as:

R _i = R _f + b _i ( R _m R _f)

where R _i is the required return for security i, R _m is the return on the market portfolio, R _f is the risk-free rate, and _i is the estimated beta for security i.