The Performance of the Capital Asset Pricing Model Prior and the Post Financial Crisis in 2008: Evidence from Ten Industries in the USA Zongming Ma Abstract: The financial crisis in 2008 raised the concern of many practitioners and academics about the validity of the capital asset pricing model. In this paper, we use the data (ranged in ten years around the 2008 financial crisis) from ten industries to test the validity of the capital asset pricing model. Our results show that the model is not effective in these ten years. However, the 2008 financial crisis had an impact on the model: investors are more averse to risk after the financial crisis than before. In this study, we find that Beta (financial elasticity) is not the only factor that can explain the excess return; more factors should be added in the model to predict the excess return of the portfolio on the financial market. Keywords: CAPM, Financial Crisis
The capital assets pricing model (CAPM) is commonly used in the field of finance. The CAPM model was first introduced by Jack Treynor (1961, 1962) and William Sharp (1964), and then was interpreted and developed by John Lintner and Jan Mossin from different views and perspectives. Based on the Markowitz’s Portfolio Theory, beta is defined as covariance of an asset which is related to market index. “The Sharpe-lintner-Mossin CAPM has been advanced to explain the relationship between the risk of a security and the equilibrium expected rate of the return required by investors to induce them to hold the outstanding supply of that security"(RogerA.Morin,1980). The CAPM model is still the core of the theory of financial investment. Since CAPM was introduced, many practitioners and academics have continued to research the model. They engaged in testing the capital asset pricing model and modifying it. Roll (1977, 1978) tested the model and Ross (1976) introduced ATP (Arbitrage Pricing Theory) which was modified from CAPM. In order to show the return- risk tradeoff in a more specific way, Black (1972) revised the capital asset pricing model. Although financial models in the real world are not accurate due to the unpredictable factors in the economy, CAPM (under some particular assumptions) have been accepted by financial practitioners and scholars. The economy, however, experienced a tough challenge in the year 2008. The financial crisis exerted a profound influence on the economy. Whether the financial crisis has affected the validity of capital asset pricing model in emerging markets or not have become a relatively new issue that people are more concerned about. In this study, we will test CAPM before and after the 2008 financial crisis, to determine whether the financial crisis would make a difference to the validity of the capital assets pricing model in emerging markets. 2
In the CAPM theory, the model states that:
~ ~ E (γ i ) = γ f + β i [ E (γ m ) − γ f ]
~ Where in general, E (γ i ) is the expected excess return on any assets in the market.
~ γ f is the risk-free rate, and E(γ m ) − γ f is what we call risk premium, which is a "reward" for ~ investors bearing risk. The model shows that E (γ i ) and β i have a linear relationship; ~ E (γ i )
~ equals to γ f if β i is zero; E (γ i ) equals to the expected return on the market if β i is one. These are the aspects that we will use the computer program R to test in this study.
In this research, we use the data from ten different industries range from telecommunications to energy corporations. The data cover ten years from July 2001 to July 2011, and includes the monthly data of expected return of the ten industries during the ten years, the risk-free rate of the interest and the excess return on the market. We divide the data into two periods: time period one is from 07/2001 to 07/2007; time period two is from 07/2009 to 07/2011. One statistical...
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Fama, E. (February 01, 1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics,33,1, 3-56.
Roger A.Morin(1980),"Market Line Theory and the Canadian Equity Market,"Journal of Business Administration 12,no.1.
Roll, R., & Ross, S. A. (2003). On the Cross-Sectional Relation between Expected Returns and Betas. In R. R. Grauer (Ed.) , Asset pricing theory and tests.
Results of time-series regression test on CAPM First-regression(before2008) First-regression(after2008)
0.53147*** (0.07745) 1.2897*** (0.1188) 0.9284*** (0.0708) 0.7238*** (0.1496) 1.7613*** (0.1011) 1.1856*** (0.1056) 0.95034*** (0.08716) 0.61094*** (0.08071) 0.6601*** (0.1091) 0.95115*** (0.06204)
0.68747*** (0.05794) 0.68747*** (0.05794) 1.22535*** (0.05412) 0.894706*** (0.110162) 0.98584*** (0.07347) 0.94925*** (0.08018) 0.79503*** (0.07759) 0.64905*** (0.0978) 0.5544*** (0.08743) 1.334*** (0.0783)
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