conceptual differences between portfolio theory and capital asset pricing model

Portfolio Theory and the Capital Asset Pricing Model (CAPM) are both fundamental concepts in finance that aim to understand the relationship between risk and return in investment portfolios. While they are related, there are some conceptual differences between the two:

1. Scope: Portfolio Theory focuses on the diversification of investments within a portfolio to manage risk and maximize returns. It considers the risk and return characteristics of individual assets and their combined effect on the portfolio. On the other hand, the CAPM is a specific pricing model that provides a framework for determining the required rate of return for an individual asset based on its systematic risk.
2. Risk Measurement: Portfolio Theory takes a broader approach to risk by considering both systematic (market) risk and unsystematic (specific) risk. It aims to reduce unsystematic risk through diversification while capturing the benefits of systematic risk. The CAPM, on the other hand, primarily focuses on systematic risk measured by beta, which represents the asset’s sensitivity to market movements.
3. Return Calculation: Portfolio Theory considers the expected return and risk of the entire portfolio, taking into account the weights of each asset and their respective returns. It looks at the portfolio level to assess the risk-return trade-off. The CAPM, in contrast, provides a specific formula to calculate the required rate of return for an individual asset based on its beta and the market risk premium.