Capital Asset Pricing Model and International Research Journal

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International Research Journal of Finance and Economics ISSN 1450-2887 Issue 4 (2006) © EuroJournals Publishing, Inc. 2006 http://www.eurojournals.com/finance.htm

Testing the Capital Asset Pricing Model (CAPM): The Case of the Emerging Greek Securities Market Grigoris Michailidis University of Macedonia, Economic and Social Sciences Department of Applied Informatics Thessaloniki, Greece E-mail: mgrigori@uom.gr Tel: 00302310891889 Stavros Tsopoglou University of Macedonia, Economic and Social Sciences Department of Applied Informatics Thessaloniki, Greece E-mail: tsopstav@uom.gr Tel: 00302310891889 Demetrios Papanastasiou University of Macedonia, Economic and Social Sciences Department of Applied Informatics Thessaloniki, Greece E-mail: papanast@uom.gr Tel: 00302310891878 Eleni Mariola Hagan School of Business, Iona College New Rochelle Abstract The article examines the Capital Asset Pricing Model (CAPM) for the Greek stock market using weekly stock returns from 100 companies listed on the Athens stock exchange for the period of January 1998 to December 2002. In order to diversify away the firm-specific part of returns thereby enhancing the precision of the beta estimates, the securities where grouped into portfolios. The findings of this article are not supportive of the theory’s basic statement that higher risk (beta) is associated with higher levels of return. The model does explain, however, excess returns and thus lends support to the linear structure of the CAPM equation. The CAPM’s prediction for the intercept is that it should equal zero and the slope should equal the excess returns on the market portfolio. The results of the study refute the above hypothesis and offer evidence against the CAPM. The tests conducted to examine the nonlinearity of the relationship between return and betas support the hypothesis that the expected return-beta relationship is linear. Additionally, this paper investigates whether the CAPM adequately captures all-important determinants of returns including the residual

International Research Journal of Finance and Economics - Issue 4 (2006) variance of stocks. The results demonstrate that residual risk has no effect on the expected returns of portfolios. Tests may provide evidence against the CAPM but they do not necessarily constitute evidence in support of any alternative model (JEL G11, G12, and G15). Key words: CAPM, Athens Stock Exchange, portfolio returns, beta, risk free rate, stocks JEL Classification: F23, G15

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I. Introduction
Investors and financial researchers have paid considerable attention during the last few years to the new equity markets that have emerged around the world. This new interest has undoubtedly been spurred by the large, and in some cases extraordinary, returns offered by these markets. Practitioners all over the world use a plethora of models in their portfolio selection process and in their attempt to assess the risk exposure to different assets. One of the most important developments in modern capital theory is the capital asset pricing model (CAPM) as developed by Sharpe [1964], Lintner [1965] and Mossin [1966]. CAPM suggests that high expected returns are associated with high levels of risk. Simply stated, CAPM postulates that the expected return on an asset above the risk-free rate is linearly related to the non-diversifiable risk as measured by the asset’s beta. Although the CAPM has been predominant in empirical work over the past 30 years and is the basis of modern portfolio theory, accumulating research has increasingly cast doubt on its ability to explain the actual movements of asset returns. The purpose of this article is to examine thoroughly if the CAPM holds true in the capital market of Greece. Tests are conducted for a period of five years (1998-2002), which is characterized by intense return volatility (covering historically high returns for the Greek Stock market as well as significant decrease in asset returns over the...
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