From Regular-Beta CAPM to Downside-Beta CAPM
Corresponding Author, Professor Department of Management Sciences COMSATS Institute of Information Technology Chak Shahzad, Park Road, Islamabad
Assistant Professor and PhD Scholar COMSATS Institute of Information Technology Chak Shahzad, Park Road, Islamabad
Shahid Mehmmod Sargana
Assistant Professor, COMSATS Institute of Information Technology Chak Shahzad, Park Road, Islamabad
Syed Kashif Saeed
PhD Scholar, COMSATS Institute of Information Technology
Chak Shahzad, Park Road, Islamabad
CAPM has come a long way and has passed the time-test and eventually is fast coming out as a winner despite the onslaught of both, APT and multi-factor CAPM. The bottom line is that CAPM is needed, dead or alive. If so, it does not mean that CAPM stays as “CAPM”. Downside risk in recent times has caught the eyes of researchers. Downside-beta CAPM (DCAPM) based on downside risk is being thought a fast replacement to CAPM. It captures almost all the features of CAPM but let goes conditions of normality and investor’s preference of both upside and downside risk. With evidence pouring in from all corners of the world especially from emerging markets, that DCAPM and its different modified versions outperforms CAPM, it seems that DCAPM is long-awaited solution for asset pricing problem.
Keywords: CAPM, anomalies, DCAPM, Value at Risk (VaR).
Section I: Introduction
The paper is one of its kinds that makes its journey back into history with the inception of CAPM and concludes with Downside-beta CAPM (DCAPM) based on downside risk, bringing the two worlds together. At least to our knowledge, CAPM and DCAPM have not been discussed simultaneously at great length, in one paper. The paper primarily focuses on empirical evidence for and against CAPM. Though these evidences are discussed in many papers but this paper categorizes the criticism which makes it easier for readers to retain it. As regarded by many, CAPM is still a solution in asset pricing whose acceptability and worldwide usage cannot be easily discarded. So relying on the same theoretical basis of CAPM, apart from the condition of normality and investor’s preference of both upside and downside risk, DCAPM comes to rescue with hard evidence. Evidence of DCAPM both from developed and emerging markets is discussed in this paper. The paper also discusses the modified versions of both CAPM and DCAPM, incorporating higher moments and time-varying betas. 189
European Journal of Social Sciences – Volume 21, Number 2 (2011) The paper is divided into four sections. The first section gives an introduction while second section presents a brief introduction of CAPM covering primarily the empirical arena of CAPM. Initially, evidence in favor of CAPM is given and then the onslaught on CAPM is discussed. The criticism on CAPM is divided into three major categories. As a savior, downside risk is brought in and CAPM is transformed into DCAPM. Third section starts with the introduction to downside risk and ends up with evidence of DCAPM worldwide with emphasis on emerging markets. Finally, fourth section is conclusion and further recommendations.
Section II. I: Introduction to CAPM
Capital Asset pricing Model (CAPM)1 is one of the most, theoretically and empirically, discussed topics in the discipline of economics and finance. Although it cannot be called an empirical success, it’s intuitively brevity has provided it a special place in literature of economics and finance. Due to above discussed attributes; it is widely used2 asset pricing model. Its simplicity and cost-effectiveness makes it superior to both multi-factor and arbitrage models. Although there are no prices on graph-only risk and return, still it is called a ‘pricing model’ because it can be used to help us...