Table of Contents

Abstract ................................................................................................................. 2
Introduction ........................................................................................................... 3
Literature Review:................................................................................................. 3
Assumptions of CAPM Model: ............................................................................ 4
Methodology ......................................................................................................... 4
Empirical Interpretation Of two-stage regression:................................................ 6
Conclusion: ........................................................................................................... 8
Abstract
Capital Asset Pricing Model (CAPM) was a great invention in financial market theory. CAPM
constitute an equilibrium linear relationship among expected return and risk of an asset. The
empirical research investigates a risk-return relationship with CAPM framework in this project
using monthly stock returns from 10 non-financial companies for the during period of January
2001 to December 2013. From the CAPM empirical research, it is concluded that that intercept
term is significantly different from zero and insignificant but there exists a positive relationship
between beta and stock return. The outcome of the study mitigates the CAPM hypothesis and
give evidence against the CAPM in stock market. Whatever, there belongs linearity on the
securities market line. The sole risk and the interaction are insignificant during the time period.
Introduction
The most significant developments in new capital is the Capital Asset Pricing Model (CAPM).
Basically, CAPM is the model that prescribes the relationship between risk and expected return.
A preview of studies applied on numerous markets in whole world agrees with the validity of
CAPM. It is within problems exist choice option under ambiguity that Markowitz [1952] and
Tobin [1958] first observed themselves. The origin of asset pricing theory remains with
Markowitz [1952] who was a promoter in proving formally that diversification of the security
minimizes the risk, unless returns on the securities are perfectly correlated. He authorized that
investors can diversify away all types of risks except the risk which comes with holding share
or stocks in general system.
This empirical study aims at testing the implication of the model system to prescribe risk-return
relationship in the capital market. This study discloses whether the CAPM is compatible
description of asset pricing in market context. Then a justification of preferring the compatible
analysis technique to as Certain the determinants of CAPM in emerging market is focused.
Previous section discloses the specification CAPM with the assumptions. Then empirical key
findings with discussion has been reported.

Literature Review:
CAPM is actually based on Markowitz (1959) and Tobin (1958), who invented “risk return
portfolio theory” depend on the utility model system of von Neumann and Morgenstern
(1953). The basic primary coordination of the CAPM is mean-variance efficiency of the
capital market portfolio. The efficiency of the market portfolio indicates that there belongs a
positive linear relationship between expected return and market beta and that is variable other
than beta would not have power in describing the expected returns of shares. There have been
several ways to test the implications of the CAPM the using historical rate of returns of
securities and the historical rate of return on a market index. - The CAPM is depend on such
unique assumptions which have to done within the object that investor wants to maximize
their expected utility wealth. Addition to the risk diversification is that all investor has
homogenous expectations on the return of the securities. Those returns of securities pursue a
normal distribution, which distinguish the phenomenon of homogeneous. There has a risk-
free rate of return which pays the opportunity to investor to lend or borrow on this rate of
return within the lack of risk. Finally, there has no taxes or other obstacles which follow to an
imperfection on every market. On creating a number of assumption, extended Markowitz’s
mean-variance framework to maintain a relation for expected excess return (the returns minus
the risk-free rate). Those returns equal return of a security of share with the return on excess
of market portfolio time, the coefficient beta – which is measure of risk in analysis. Most of
the tests of CAPM have been perform by determining cross-sectional relation among average
return on asset and their beta, over the time interval, and compare to estimated relationship
implied by CAPM. In absence of riskless asset Black (1972) has suggest to use zero (0) beta
portfolio, Rf, that is equal to zero, as proxy for the riskless asset. On this case, CAPM depend
on two factors; zero beta and non-zero beta portfolio and it refer to as a two-factor CAPM.
The zero-beta model implies the equilibrium expected returns on assets to be the function of
market factor which defined by the returns on market portfolios and a beta factor defined by
the returns on zero-beta portfolios which is minimum variances portfolio and so, it is
uncorrelated with capital market portfolio. Zero-beta portfolio plays the disposition
equivalent to risk-free rate of returns in the Sharpe-Lintner model. If intercept term is zero, it
implies that CAPM hold. During on the process of the tests and after testing traditional
CAPM, we proceed to verification of zero-beta or two-factors model in the ASE.

Primary initial test of the CAPM were done by Black, Fama and MacBeth - FM (1973).
It mentioned earlier that, these tests involve a two-stage procedure. The findings report that
the CAPM did not hold in the tested period. Fama and MacBeth (1973) also reorted monthly
market return for all NYSE stocks over 1926-1929. After that they ranked all stock by beta and
form 20 portfolios. They estimated all their average return and their beta for the period of 1930-
1934, actualy the same way as BJS did, and used those betas to determine portfolio return in
the subsequent period 1935- 1938. The result discussed that coefficient of beta is statistically
insignificant and the value lies small for much sub-period. They also get that the residual risk
has no effect on security return. The result of test intercept was greater than the risk-free rate
and the result identified that the CAPM did not hold.

Assumptions of CAPM Model:

1. Capital markets are flawless and productive where there is free stream of data and no
exchange costs.
2. There are no individual and corporate expenses.
3. All financial specialists are single period riches expands.
4. Investors have homogeneous or comparable assumptions about dangers and returns of
a security.
5. All speculators can obtain and tend at the hazard free rate which is expected to stay
consistent.
6. There is no expansion in the economy.
7. Investors are chance loath.
8. There is typical appropriation of profits of a given security and that there exists a very
much expanded market portfolio without unsystematic hazard.

Methodology
To verify the model of CAPM in our market, we use 10 company data. We take price index of
every company on every month. we calculate this subject to determine whether CAPM holds
or not.
We calculate individual stock return (Ri) and Portfolio market return (Rm)also. We use this
formula Ri = LN (Pt/Pt-1) to determine Ri & Rm, we get this return.
After we run regression model to find the beta of company, as well as intercept of t-statistics
& p value, we take (Ri-Rf) of individual stock as an independent variable (Y) & (Rm-Rf) as a
dependent variable (X).
Where,
Rf = Risk free rate
Rm = Return of Market Portfolio
Ri = Return on individual security
By run the first regression model, we find intercept (α) is difference between excess average
stock rate price and expected CAPM return. Intercept referred by p value of regression model.
On first regression model, we also get beta β represent the systematic risk of company stock.
We also find the unsystematic risk of company as standard error.
The equation model is = rit−rft=ai+bi(rMt−rft)+eit .
To run the second-pass regression we use every companies “Average Excess Stock Return “as
dependent variable Y & Systematic Risk (β) of every company plus unsystematic risk as
Residual Variance as independent variable X. Methodology
To verify the model of CAPM in our market, we use 10 company data. We take price index of
every company on every month. we calculate this subject to determine whether CAPM holds
or not.
We calculate individual stock return (Ri) and Portfolio market return (Rm)also. We use this
formula Ri = LN (Pt/Pt-1) to determine Ri & Rm, we get this return.
After we run regression model to find the beta of company, as well as intercept of t-statistics
& p value, we take (Ri-Rf) of individual stock as an independent variable (Y) & (Rm-Rf) as a
dependent variable (X).
Where,
Rf = Risk free rate
Rm = Return of Market Portfolio
Ri = Return on individual security
By run the first regression model, we find intercept (α) is difference between excess average
stock rate price and expected CAPM return. Intercept referred by p value of regression
model. On first regression model, we also get beta β represent the systematic risk of company
stock. We also find the unsystematic risk of company as standard error.
To run the second-pass regression we use every companies “Average Excess Stock Return
“as dependent variable Y & Systematic Risk (β) of every company plus unsystematic risk as
Residual Variance as independent variable X.
Empirical Interpretation Of two-stage regression:
Analysis of first pass regression:
INTERCEPT
Systemat t- P- average System
ic Risk statistics value excess atic Residual
stock Risk Variance
return
β r β 𝛔2 ϵit
1 Padma Oil Co.Ltd. 0.50340 - 0.06274 - 0.50340 0.17418
5096 1.876307 044 0.06239 51 6847
393 03
2 Eastern Lubricants 0.56295 - 0.06088 - 0.56295 0.16929
Ltd. 3514 1.889928 015 0.06494 351 6961
473 91
3 City Bank Ltd 1.14421 - 0.36720 - 1.14421 0.24733
317 0.904705 937 0.08683 317 5909
995 99
4 IFIC Bank Ltd. 1.11741 - 0.39279 - 1.11741 0.26518
5779 0.857265 519 0.08573 578 422
712 88
5 Aziz Pipes Ltd 0.85494 - 0.16318 - 0.85494 0.24232
1431 1.401977 377 0.08315 143 7033
042 7
6 Bangladesh Lamps 0.94241 - 0.31586 - 0.94241 0.20575
Limited 0944 1.006672 688 0.07394 094 819
49 17
7 Imam Button 0.93865 - 0.22486 - 0.93865 0.26443
Industries Ltd. 3633 1.006672 599 0.08593 363 0329
49 99
8 Keya Cosmetics 0.99116 - 0.54393 - 0.99116 0.14227
Ltd. 519 0.608390 556 0.06386 519 0343
971 39
9 Stylecraft Limited 0.72553 - 0.26122 - 0.72553 0.21505
989 1.128166 157 0.06573 989 341
15 12
1 Rahim Textile Mills 1.09834 0.040622 0.96768 - 1.09834 0.26861
0 Ltd. 0005 942 452 0.06189 0524
2

The equation model is rit−rft=ai+bi(rMt−rft)+eit .

p-values of this empirical study implies that null hypothesis is rejected as they are lower than
0.05 and intercept is not equal to zero. In first pass regression, all companies intercept is not
equal to zero and lower to .05 intercept value. This result rejects the null hypothesis. Thus,
reject null hypothesis and implies that these 10 companies are inconsistent with the standard
CAPM.

R- square of every company is low which indicates that the security does not act much like
the index. Here the t-statistics is between +1.96 and -1.96, the null hypothesis is accepted at
5% significance level. Here every companies t-statistics belongs to this value.

Analysis of second pass regression:

Standard Significa
Coefficients Error t Stat P-value R Square F F
Intercept α -0.037439154 0.015641684 -2.3935501 0.047918
β͡ 0.047918149 0.016951471 -0.5939441 0.571236 0.43952121 2.7446609 0.131812
σ2(ε𝑖𝑡) -0.123336448 0.084367338 -1.4618981 0.187161

On this regression use 139 observations of this 10 companies in 12 years. Here the coefficient
of e beta, α1, is negative (-0.0100682263719488) and statistically significant. Here the
intercept term not equal to zero & not lower to .05, it is (0.571236414563395) in which t-
statistics is between +1.96 to _1.96. It indicates that the CAPM do not maintain the linear
positive relationship, thus higher returns are not associated with higher risk. The unsystematic
risk on returns implies that coefficient of variance of residuals σ(ε𝑖𝑡), α2 is also negative (-
0.123336448162581) and have significant influence. Here the intercept term is
(0.187160898844083) which excess of .05 & this finding contradicts the standard of the CAPM
and states that unsystematic risk has explanatory power and it also influences the return.
We know that, small value of R-square is less then 70% indicates that variables β and σ(ε𝑖𝑡)
have few explanatory power to describe the proportion of variation in average excess return.
Here R-square is 43% which indicates the security does not act like the index of market. F-
statistics which indicates that less than 0.05 provide a conclusion that there is a linear
interdependence between the dependent and independent variables on the empirical study. Here
significance F is (0.131812664036839) which indicate there has no linear interdependence in
dependent and independent variables according to the assumptions of CAPM.
Conclusion:

The empirical study examines the CAPM and investigates a risk-return relationship with the
CAPM framework model using 10 company’s data. This finding of empirical study is not
supportive to the CAPM theory’s basic hypothesis in both cases-individual companies and
portfolios. The outcome contradicts with the CAPM another hypothesis in which intercept term
should equal to zero or less than.05 Based on empirical results of the first pass regression,
among the 10 companies, intercept term is not equal to zero. Estimated R-square of 10
companies is very low and indicates that market excess return has low explanatory power. In
second pass regression, the coefficient of beta is negative which have no positive relationship
of return with beta. Estimated R-square is 43% which indicates the security does not act like
the index of market. Beta of residual variance is negative and statistically significant which
overlaps CAPM assumption as unsystematic risks are supposed to have no effect on rate of
return. So, on this empirical study, intercept is not equal to zero and R-square is 43% which is
not required percentage as CAPM assumption. So, the CAPM model does not hold on the
companies.

The study conducts to whether the CAPM adequately includes all significant aspects of market
condition by engaging the unique risk and the interaction term of systematic risk and unique
risk of stocks. A comparative study on the asset pricing model could also be pretended to more
thorough analysis.