ABSTRACT
This entry discusses asset pricing, its theories and applications. It starts by reviewing portfolio theory and the concept of diversification. It then introduces the centerpiece of asset pricing model, the capital asset pricing model (CAPM). This is followed by a review of empirical testing results of the model. The failure of the model in explaining and predicting market data motivated the modification and development of new and more complex models. The entry, subsequently, surveys and assesses selected alternative models, including the arbitrage pricing theory (APT), other multifactor models, conditional CAPMs, and CAPM with higher-order comoments.
