How does CAPM typically approach the analysis of market risk?

The Capital Asset Pricing Model (CAPM) is a widely used financial model that provides a method for determining the expected return on an investment given its risk relative to the market. CAPM typically approaches the analysis of market risk through the lens of a single market factor, which is the systematic risk represented by beta. This beta value quantifies the sensitivity of an investment's returns to the overall market returns, allowing investors to understand how the asset's price is likely to move in relation to market changes.

The model assumes that all investors will diversify their portfolios to eliminate unsystematic risk (the risk unique to a particular company or industry). As a result, CAPM focuses primarily on systematic risk, the portion of risk that cannot be diversified away, and uses beta as the sole measure to assess this risk. Thus, by concentrating on this single market factor, CAPM provides a straightforward and clear way to evaluate the required return for taking on that risk, which is why this approach is fundamental to the CAPM framework.

Understanding this concept is crucial for investors and financial analysts, as it illustrates how market risk can be quantified and used to make informed investment decisions.