Capital Asset Pricing Model:

The works by Sharpe by Lintner and by Mossin on the Capital Asset Pricing Model (CAPM for short) is concerned with economic equilibrium assuming all investors optimize in the particular manner that Harry Markowitz  proposed.  The CAPM is an equilibrium model of asset pricing.  As such the CAPM provides an understanding of the behavior of security prices, the risk-return  relationship, and the appropriate measure of risk for securities.

In the CAPM some additional assumptions over and above those made for Markowitz's portfolio theory, are made. Theses are,  first, that unrestricted borrowing and lending can take place at the risk free rate; secondly, that investors have homogeneous expectations regarding the means, variances, and covariances of security returns; and finally, that there are no imperfections in the capital market such as transaction costs, and also that there are no taxes.

Given these assumptions, the implications are that there is a capital asset pricing model that consists of a capital market line and a security market line. To understand this, we must first remember that there are some assets that are risk free. In Markowitz's theory, no risk-free asset was considered: portfolio theory suggests that efficient portfolios can be constructed using expected returns and variance. Once a risk-free asset in brought into the picture, and assuming the investor can borrow and lend at the risk-free rate (an assumption explicitly made in the CAPM) the picture changes. It can be shown that the investor can reach a  point with higher expected returns than with merely the Markowitz efficient frontier. The investor will select a portfolio on an upward sloping line in the (expected) return-risk plane [the line starts on the y-axis at a point on the expected-return axis (y axis) that depicts the risk-free return and slopes upward, tangent to the Markowitz efficient curve at a certain point. This line is called the capital market line. To the left of the point of tangency of the capital market line to the Markowitz  efficient portfolio curve,  there will be points on the line vertically above point on the Markov efficient frontier. This shows that with risk-free asset in the portfolio, the investor will select a portfolio on the line, representing a combination of borrowing or lending at the risk-free rate  and purchases of Markowitz efficient portfolio. There is a theorem that says that all risk-averse investors will hold a combination of the risk-free asset and market portfolio, known as the two-fund separation theorem.