An empirical testing of the capital asset pricing model in Macedonian Stock Exchange.

Author:Beqiri, Zana

    The relation between risk and return is one of the most important issues in finance. It is widely known that investing in risky assets as opposed to risk free ones, implies higher returns as a reward for the additional risk taken. The first model to quantify this risk-return relationship and to give managers and investors a tool to use when making their investment decisions, measuring the cost of capital, managing and evaluating portfolios, is the Capital Asset Pricing Model. Since its introduction CAPM has been one of the most challenging topics in financial economics. The basic CAPM was developed almost simultaneously during the mid 1960s by William Sharpe (Sharpe, 1964), John Lintner (Lintner, 1965), and Jan Mossin (Mossin, 1966), and was quickly embraced by academic researchers. The founding theory for the development of CAPM was laid by Harry Markowitz (Markowitz, 1959) with his mean variance analysis, where he finds how rationale investors should allocate their wealth among the variable assets available, given that they are one-period utility maximizers. It is these characteristics of the investment decision that the Sharpe-Lintner asset-pricing model uses to derive the equilibrium relationship between risk and return. The formal development of the CAPM requires several assumptions about investors and markets. (Smart, Megginson, Gitman, 2008)

  2. Investors are risk averse and require higher returns on riskier investments.

  3. Because investors can diversify, they care only about the systematic risk of any investment. The market offers no reward for bearing unsystematic risk.

  4. Some portfolios are better than others. Portfolios that maximize expected return for any level of risk are efficient portfolios. Investors are price takers and have homogeneous expectations.

  5. If investors can borrow and lend at the risk-free rate, then there exists a single risky portfolio that dominates all others. Only portfolios consisting of the risk-free asset and the optimal risky portfolio are efficient.

  6. There are no market imperfections such as taxes, transaction costs or restrictions on other sellings.

  7. Investors hold assets for one holding period.


    There is a considerable literature regarding empirical tests of the CAPM. Most of the empirical tests employ the two pass regression technique, of first estimating betas using a time series regression and then testing the hypothesis implied by the CAPM by running a cross section regression. Two of the earliest and most important studies were done by Black, Jensen and Scholes (Black, Jensen, & Scholes, 1972) and by Fama and MacBeth (Fama & MacBeth, 1973). They compared actual average returns with those predicted by the security market line, and concluded that expected returns were related to betas, as predicted by the CAPM, rather than to other measures of risk such as the security's volatility. However they did find some deviation from the security market line. In particular, the empirically estimated security market line is somewhat flatter than that predicted by the CAPM. That is, low-beta stocks have tended to perform somewhat better than the CAPM predicts, while the highest beta stocks do worse. Other influential papers published by Eugene Fama and Kenneth French in 1992 (Fama & French, 1992) and 1993 (Fama & French, Common Risk Factors in the Returns on Stocks and Bonds, 1993) argue that based on more current data and taking other characteristics of securities into account, beta is not helpful in explaining average returns. Richard Roll (Roll, 1977) pointed out that any failure of the CAPM may simply be the result of our failure to find a good measure of the market...

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