An Empirical and Theoretical Analysis of Capital Asset Pricing ModelUniversal-Publishers, Nov 18, 2010 The problem addressed in this dissertation research was the inability of the single-factor capital asset pricing model (CAPM) to identify relevant risk factors that investors consider in forming their return expectations for investing in individual stocks. Identifying the appropriate risk factors is important for investment decision making and is pertinent to the formation of stocks' prices in the stock market. Therefore, the purpose of this study was to examine theoretical and empirical validity of the CAPM and to develop and test a multifactor model to address and resolve the empirical shortcomings of the single-factor CAPM. To verify the empirical validity of the standard CAPM and of the multifactor model, five hypotheses were developed and tested against historical monthly data for U.S. public companies. Testing the CAPM hypothesis revealed that the explanatory power of the overall stock market rate of return in explaining individual stock's expected rates of return is very weak, suggesting the existence of other risk factors. Testing of the other hypotheses verified that the implied volatility of the overall market as a systematic risk factor and the companies' size and financial leverage as nonsystematic risk factors are important in determining stock's expected returns and investors should consider these factors in their investment decisions. The findings of this research have important implications for social change. The outcome of this study can change the way individual and institutional investors as well as corporations make investment decisions and thus change the equilibrium prices in the stock market. These changes in turn could lead to significant changes in the resource allocation in the economy, in the economy's production capacity and production composition, and in the employment structure of the society. |
Contents
6 | |
Assumptions | 13 |
The Significance of the Study | 22 |
Capital Asset Pricing Model CAPM | 42 |
Linters Results for Test of the CAPM | 72 |
BJS Results for Test of the CAPM | 75 |
Fama and MacBeth Results for Test of the CAPM | 77 |
The Arbitrage Pricing Theory | 80 |
Statistical Significance of Regression Coefficients | 111 |
Percentage Distribution of R Square Values | 112 |
Stocks Average Monthly Returns versus their Betas and Nonsystematic Risks Partial | 113 |
Stocks Average Expected Monthly Returns versus Systematic and Nonsystematic Risks | 114 |
Second Part | 115 |
Total Assets Market Value Measurement for Hewlett Packard Company HPQ | 118 |
Average Monthly Rates of Return of Stocks of Small Companies versus Large Companies | 119 |
Results of the Z Test for Comparing Small and Large Companies Average Returns | 120 |
METHODOLOGY AND RESEARCH DESIGN | 86 |
Regression Statistics for GM Risk Premium against SP 500 Index Risk Premium | 92 |
Regression Statistics for BAC Risk Premium against SP500 Index Risk Premium | 93 |
Data Collection | 94 |
Data Analysis | 95 |
Summary | 103 |
Time Series Data on Monthly Excess Returns of Merck Companys Stock and Monthly Excess Returns of SP500 Stock Index January 1995 to Decem... | 109 |
MRK Monthly Excess Returns versus SP 500 Monthly Excess Returns | 110 |
Financial Leverage Measurement for Hewlett Packard Company HPQ | 122 |
Average Monthly Rates of Return of Stocks of Low Financial Leverage | 123 |
Time Series Data on Monthly Excess Returns of Yahoo Corporations Stock | 136 |
Summary | 148 |
SUMMARY CONCLUSIONS AND RECOMMENDATIONS | 154 |
Implications for Social Change | 161 |
CURRICULUM VITAE | 168 |
Common terms and phrases
adjusted R-square asset pricing average monthly rate average monthly returns beta coefficients beta estimates calculated capital market company’s correlation covariances different from zero efficient frontier excess return expected rate expected return expected return-beta relationship financial leverage companies H₁ HFLLF high financial leverage high operating leverage holding period hypothesis five hypothesis three implied volatility independent variables individual securities large companies low financial leverage low operating leverage market portfolio market return Markowitz model measured monthly average rates multifactor model null and alternate null hypothesis operating leverage companies optimal portfolio P-value portfolio selection proxy rate of return regression coefficients return of high return of low return of stocks risk aversion risk free risk premium risk-free asset risk-free rate sample period security market line significantly different small companies specific standard CAPM standard error Stock Index stock market study period subsample systematic risk test of hypothesis utility indifference curve