Intertemporal Capital Asset Pricing Model - ICAPM

DEFINITION of 'Intertemporal Capital Asset Pricing Model - ICAPM'

A financial model that takes into account major sources of risk when optimizing consumption over a period of time. The intertemporal capital asset pricing model (ICAPM) assumes that security returns are normally distributed over multiple time periods, and that all future consumption will be funded by security returns.

ICAPM was described by Nobel laureate Robert Merton in 1973.

BREAKING DOWN 'Intertemporal Capital Asset Pricing Model - ICAPM'

ICAPM is a consumption-based asset-pricing model, and it goes a step further than CAPM in taking into account how investors participate in the market. Most investors do not participate in financial markets for one year, but instead for multiple years. Over longer time periods, investment opportunities might shift as expectations of risk change, resulting in situations in which investors may wish to hedge. For example, an investment may perform better in bear markets, and an investor may consider holding that asset if a downturn in the business cycle is expected.

ICAPM uses mean-variance analysis to create normal distribution of consumption risk over time. Because ICAPM covers multiple time periods, multiple beta coefficients are used to determine how many security concerns covary with a basket of risky securities.

A criticism of ICAPM is that it assumes that consumer expectations are homogenous, meaning that it cannot take into account individual risk preferences.

RELATED TERMS
  1. Intertemporal Equilibrium

    An economic concept that holds that the equilibrium of the economy ...
  2. International Capital Asset Pricing ...

    A financial model that extends the concept of the capital asset ...
  3. Robert C. Merton

    An American economist who won the 1997 Nobel Memorial Prize in ...
  4. Merton Model

    A model, named after the financial scholar Robert C. Merton, ...
  5. Multi-Factor Model

    A financial model that employs multiple factors in its computations ...
  6. Hull–White Model

    A single-factor interest model used to price derivatives. The ...
Related Articles
  1. Investing

    Introduction To International CAPM

    ICAPM is one of several models used to determine the required return on an asset, discover its limitations and how to use it.
  2. Investing

    The Capital Asset Pricing Model: An Overview

    CAPM helps you determine what return you deserve for putting your money at risk.
  3. Investing

    Understanding Financial Models

    A financial model is a representation of some aspects of a firm or given security. It uses historical numbers to create calculations that inform financial recommendations or predict future financial ...
  4. Managing Wealth

    Using Normal Distribution Formula To Optimize Your Portfolio

    Normal or bell curve distribution can be used in portfolio theory to help portfolio managers maximize return and minimize risk.
  5. Investing

    Catch On To The CCAPM

    The consumption capital asset pricing model smoothes over some of CAPM's weaknesses to make sense of risk aversion.
  6. Investing

    What is a Business Model?

    Business model is the term for a company’s plan as to how it will earn revenue.
  7. Investing

    Is Apple's Stock Over Valued Or Undervalued?

    Despite several drawbacks, the CAPM gives an overview of the level of return that investors should expect for bearing only systematic risk. Applying Apple, we get annual expected return of about ...
  8. Trading

    Valuation Models: Apple’s Stock Analysis With CAPM

    The capital asset pricing model, or the CAPM, estimates the expected return of an asset based on the systematic risk of the asset’s return.
  9. Investing

    How Investment Risk Is Quantified

    FInancial advisors and wealth management firms use a variety of tools based in Modern portfolio theory to quantify investment risk.
  10. Investing

    DCF Vs. Comparables: Which One To Use

    DCF and Comparables models are widely used in equity valuation. We explain the pros and cons of each method.
RELATED FAQS
  1. According to the CAPM, the expected return on a stock, that is part of a portfolio, ...

    A. the covariance between the stock and the market. B. the variance of the market. C. the market risk premium. D. ... Read Answer >>
  2. How is the Capital Asset Pricing Model (CAPM) represented in the Security Market ...

    Learn about the capital asset pricing model and the security market line and how the model is used in the calculation and ... Read Answer >>
  3. What is the difference between induced consumption and autonomous consumption?

    Explore the difference between autonomous consumption and induced consumption. Simplify the world of economics by understanding ... Read Answer >>
  4. What is the average return on equity for a company in the electronics sector?

    Learn about the Black-Scholes option pricing model and the binomial options model, and understand the advantages of the binomial ... Read Answer >>
  5. How does market risk affect the cost of capital?

    Find out how market risk directly affects the total cost of capital, including how to use the capital asset pricing model ... Read Answer >>
  6. How accurate is the equity risk premium in evaluating a stock?

    Learn about the drawbacks of using the equity risk premium to evaluate a stock, and understand how it is calculated using ... Read Answer >>
Hot Definitions
  1. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  2. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  3. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  4. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
  5. Russell 3000 Index

    A market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of ...
  6. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative to straightforward market capitalization. Enterprise value is ...
Trading Center