Modified Capital Asset Pricing Model

The CAPM or capital asset pricing model believes that the expected excess return over the risk-free rate is beta times the excess market return over the risk-free rate.

μ = θ + β (ν – θ)

Where μ is the expected stock return, θ is the risk-free return, ν is the expected market return, and β is beta coefficient.

I believe the stock market is mainly composed of two kinds of players – investors and traders. The investors are looking for long-term investment gains while traders are looking for short-term investment gains. The long-term investment gains are related to the expected return of stocks (mu) while the short-term investment gains are associated with the volatility of stocks (sigma). The total return is the balance of the interests of the traders and investors can be summarized by the following equation.

R = θ + α (μ – θ) + β (σ – θ)

Where α and β are alpha and beta coefficients.

In other words, the total return is a linear combination of the excess return of investors and the excess return of traders. A portion of the total return comes from the long-term holdings while another portion of the total return derives from the trading activities.