An Analysis of the Relationship between Risk and Expected Return in Malaysia Stock Market: Test of the CAPM

Abstract

Investment theory describes the concept of relationship between risk and return. Capital Model Asset Pricing Model (CAPM) was based on the risk and return relationship. CAPM described that asset’s expected return that is above the risk free rate is directly related to the non-diversifiable risk that is measure by beta. Focus of this study is to identify the impacts of risk toward the stock return in Malaysia stock market during the year 2007 to 2015 by testing on the applicability of Capital Asset Pricing Model. The data is from monthly stock returns from 24 companies listed on the stock exchange for investigation. The analysis of monthly stock market closing indexes from using regression model was carried out on the standard CAPM model. When testing the CAPM model for the whole period, it has not showed strong evidence that support the validity of this model and in order to get better estimates, this study divided the whole sample into 3 sub periods of five years each. The study found high beta value does not related to higher level in stock return. The positive relationship between systematic risk and return does not have a strong evidence to support it. The research also identify that the securities market line has direct relationship between risk and return. The unsystematic risk does not have an effect on the return. It means that stock prices cannot be effectively predicted by CAPM and Malaysia Stock and the validity of CAPM does not exist in Malaysia Stock Exchange Market for the period 2007-2015 due to some limitations such as time frame, sample size and others. This paper suggest a different assets pricing model and takes into consideration of some related variables in predicting future stocks returns. This research provides important implication to investors, analysts, stock brokers, speculators, fund managers, practitioners, relevant authorities, and government.

Sermaye Varlıkları Fiyatlama Modellerinin Analizi: Endonezya Menkul Kıymetler Borsası (IDX) Bankacılık Sektöründen Kanıt

“…(Hasan et al, 2012) who explained that the Capital Asset Pricing Model (CAPM), is a valid indicator of systematic risk, but the CAPM analysis in their research was inconsistent and could not find complete support from the CAPM model. (Husein &Hasanah, 2017), andRui et al, (2018) cannot prove Markowitz's portfolio theory. This is explained by the number of beta market (β_m) beta value below 1 indicating that fluctuations in stock returns do not follow the movement of market fluctuations.…”

“…The Capital Asset Pricing Model (CAPM) was first put forward by Markowitz (1952) and developed by Sharpe, Lintner, and Mossin in the 1960s. This model also acts as a key element of how the market can assess the return of each security along with different levels of risk (Rui et al, 2018). Several research results also show that CAPM analysis is a very useful item in investment management tools and investors trust it to evaluate project profitability (Pacho, 2014;Chiang & Zhang, 2018;Widianingsih, 2019;Wahyuny & Gunarsih, 2020;Pramono et al, 2022).…”

“…which is long-term. In selecting investments, investors must be careful because every business contains risk, between risk and return has a linear (unidirectional) relationship, which means that the greater the expected return, the greater the risk (Sartono, 2005) or in other words, securities with a higher beta should have more expected return than security with a lower beta (Rui et al, 2018). The results of research conducted (Giva, 2015) on companies listed on the Nairobi Stock Exchange explain that there is a moderate correlation between risk and return.…”

Analysis of the State-of-art Portfolio Theory

“…The asset is deemed to have outperformed if the actual return is higher than the projected return calculated using the CAPM. [13]. It is crucial to remember that CAPM has its limitations even though it offers a helpful framework for comprehending risk and expected return.…”

How rational is gambling?

“…This link is represented by the capital market line. Along this line, there is a constant rate of substitution between the per dollar expected yield and the per dollar standard deviation of the yield (see Pilbeam, 2018; Rui et al., 2018; Suroso et al., 2018; Copeland et al., 2005; Mossin, 1966; Sharpe, 1964). An investor choosing higher risks is thus rewarded with higher expected returns.…”