Further Evidence on the Validity of CAPM: the Istanbul Stock Exchange Application

Abstract

As one of the most important models in the finance literature, the Capital Asset Pricing Model (CAPM) assumes the existence of a positive and linear relationship between the systematic risk and required rates of return on stocks. The model is extensively researched in the academia and frequently used in business world since its development half a century ago. Its popularity comes from the simplification it provides for the complex process of asset pricing by making the assumption that only one single factor affects stock returns. But, as this is an unrealistic assumption, the validity of the model in its standard (unconditional) form is repeatedly rejected by empirical tests. Pettengill et al., (1995) developed an alternative conditional CAPM approach where the standard model is improved by taking bull and bear market conditions into consideration. According to this model, there is a positive (negative) risk-return relationship during up (down) market periods. Using this reasoning, Pettengill et al., (1995) tested up and down market periods separately and reached highly significant results that support CAPM. In this study, both the unconditional and conditional versions of CAPM are tested in the Istanbul Stock Exchange (ISE) for the period of nine years from 2003 to 2011. The test period is divided into four sub-periods. The unconditional CAPM is rejected for the sample period. A result of the conditional test shows that there is a statistically significant conditional relationship during some sub-periods. However, since the risk-return relationship in up and down markets is not symmetric, this conditional relationship does not indicate a positive risk-return tradeoff. Thus, CAPM may not be a useful asset pricing model for the ISE.

Further evidence on the validity of CAPM: The Warsaw Stock Exchange application

“…This approach was reflected in many studies. Research showed positive risk-return relationships which is consistent with the postulates of the CAPM (Bilgin & Basti, 2014;Fletcher, 2000;Jagannathan & Wang, 1996;Theriou, Aggelidis, Maditinos, & Šević, 2010;Trzpiot & Krężołek, 2006). The results obtained by Galagedera, Henry, & Silvapulle (2003) based on conditional regression illuminate often pessimistic conclusions regarding the equilibrium model.…”

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

“…(66) had done research in Malaysia Stock Exchange and the result is consistent with our findings which linear reltionship between beta and return does exist. Some earlier researches such as (47,67,68) also support that beta and stock return has a linear relationship in their research. Expected return-beta relationship is linear also was being proven in the Amman Stock Exchange (49).…”

“…Many studies prove an empirical result of there is a significant positively linkage between realised return and systematic risk as measured by beta, and there is linear relationship arise between risk and return (44)(45)(46). (47) and (48) also proved that there was a linear relationship between beta and return in Istanbul stock exchange. Expected return-beta relationship is linear also was being proven in the Amman Stock Exchange (49)In Australian Industrial equity market, cross sectional relationship between beta and average return is also in a situation of linear(50).…”

Validity of Capital Assets Pricing Model (CAPM) (Empirical Evidences from Amman Stock Exchange)

“…The risk of an asset can be measured by its responsiveness to that single factor. If the systematic risk and return relationship implied in this basic model could be validated in real world stock markets that would be a true revolution in finance (Bilgin and Basti, 2014).…”