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Ch15 Empirical Tests of CAPM

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7 visualizzazioni40 pagineCh15 Empirical Tests of CAPM

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Lqulllbrlum Models

1he ModelsLxAnLe LxpecLaLlons and LxosL 1esLs

Lmplrlcal 1esLs of Lhe CAM

1esLlng Some AlLernaLlve lorms of Lhe CAM Model

1esLlng Lhe osL1ax lorm of Lhe CAM Model

Some 8eservaLlons abouL 1radlLlonal 1esLs of Ceneral

Lqulllbrlum 8elaLlonshlps and Some new 8esearch

Concluslon

Appendlx 8andom Lrrors ln 8eLa and 8las ln Lhe

arameLers of Lhe CAM

The Models Ex-Ante Expectations and Ex-Post

Tests

The Modelsare based on expectations. All variables are expressed in terms

of future values.

However all tests of the CAPM have been performed using ex-post or

observed values for the variables.

The simple form of CAPM model is:

Testing this model ex-post requires three assumptions be satisfied:

1. The market model holds in every period.

2. The CAPM model holds in every period.

3. The beta is stable over time.

) (

Z M i Z i

R R R R .

) (

M i i

R R R R .

it Mt i it

e R R R R )

~

(

~

.

Lmplrlcal 1esLs of Lhe CAM

Some Hypotheses of the CAPM

1. High risk (Beta) should be associated with high

return

2. Linear relationship between beta and return

3. No added return for bearing non-market risk.

A Slmple 1esL of Lhe CAM

Sharpe and Copper (1972) sLudy Lo lnvesLlgaLe

Lhe relaLlonshlp beLween 8eLa and reLurn

Figure 15.1

Estimated Security Market Line.

Sharpe and Copper (1972) SLudy

Test of whether shares with higher betas carry higher returns.

New York Stock Exchange, time period: 1931-1967.

Construct portfolios with different betas

1. First regressing individual asset returns on market returns (based on

five years).

2. Once a year all shares were divided into ten categories ranked by

their beta.

3. A portfolio for each category was formed (equally weighted).

4. nvestment strategy: hold shares in one category only, over the entire

period (1931-1967).

5. Regress portfolio return on its beta: Ri = a

1

+ a

2

b

i

+ q

i

They find a

1

=5.54 and a

2

=12.75.

Sharpe and Copper (1972) SLudy

Conclusions:

Shares with higher betas generate higher returns: a2>0.

Buying shares with higher forecasted betas lead to holding

portfolios with higher betas (i.e. betas are stable over time).

More than 95% in the variation in expected return

explained by differences in beta (looks as if there is a linear

relationship between beta and realized average return).

The intercept greater than riskless rate of return

(5.54>2%).

The slope (a

2

) is smaller than the market premium.

Lintner (reproduced by Douglas (1968)

First regression

R

it

= d

i

+ b

i

R

mt

+ e

it

yearly returns, 301 common stocks, 1954-1963

Second regression R

i

= a

1

+ a

2

b

i

+ a

3

S

2

ei

+ q

i

S

2

ei

is the variance of the fitted residual from the first regression.

f the standard CAPM is true then a

1

should equal R

f

,

a

2

should equal Rm-Rf, and a

3

should equal zero.

f the Zero-Beta CAPM is true then a1 should equal R

z

, a

2

should equal (R

m

-R

z

)

and a

3

should equal zero.

The result was

a1 = 0.108

a2 = 0.063

a3 = 0.237 (both a

2

and a

3

are significantly different from zero at the 0.01 level)

Seems to violate the CAPM!

Empirical Evaluation of CAPM

Long-run average returns are significantly related to beta:

The dots show the actual average risk premiums from portfolios with

different betas.

high beta portfolios generated higher average returns

high beta portfolios fall below SML

low beta portfolios land above SML

a line fitted to the 10 portfolios

would be flatter than SML.

(Source: Fisher Black, "Beta and return.)

Empirical Evaluation of CAPM

(Source: Fisher Black, "Beta and return.)

Empirical Evaluation of CAPM

The dots show the actual average risk premiums from portfolios with

Different betas over different periods. The relation between beta and

actual average return has been much weaker since the mid-1960s.

CAPM does not seem to work well over the last 30 years:

(Source: Fisher Black, "Beta and return.)

Fama and French and The Three Factor Model

Fama and French examined 9,500 stocks between 1963

and 1990, concluding that a stock's risk, measured by beta,

was not a reliable predictor of performance.

They found factors describing "value (HML) and "size

(SML) to be the most significant factors, outside of market

risk, for explaining the realized returns of publicly traded

stock.

.

S

measures the level of exposure to size risk and .

H

measures the level of exposure to value risk.

ML SMB R R R R

S M i i

. . . ) (

Fama and French SMB and HML Factors

%he SMB Factor: Accounting for the Size

Premium

SMB, which stands for Small Minus Big, is

designed to measure the additional return

investors have historically received by

investing in stocks of companies with

relatively small market capitalization.

Fama and French SMB and HML Factors

HML, which is short for High Minus Low, has been

constructed to measure the "value premium provided to

investors for investing in companies with high book-to-

market values

FAMA and FRENCH AND THE THREE FACTOR

MODEL

Fama and French-Factors other than beta seem important in pricing assets:

Source: G. Fama and K. French, "The Cross-Section of Expected Stock Returns.

FAMA and FRENCH AND THE THREE FACTOR

MODEL

FAMA and FRENCH AND THE THREE FACTOR

MODEL

nterpretations of the Factors

n reality, the SMB and HML factors first drew attention

and continue to be the most commonly used simply

because they workthey have shown a greater

predictive power of any two additional factors that

researchers have tested often yielding an R

2

value of

approximately 0.95. %hat

Being said, causal explanations for SMB are appealing

from a theoretical perspective, but for HML, the labeling

of it as a "risk factor has spurred much discussion.

Problem with Fama and French Three Factor Model

Robert D. Coleman- Asset Pricing Simultaneity, Three-

Factor Model and Cost Analysis, ndian Journal of

Economics and Business, 2005

He argues that size, value and other pricing entailing

factors are not scientifically valid in an asset pricing

model of return estimated and rested by statistical

methods.

n his 2006 paper, he shows that asset pricing models of

return with risk factors that entail either shares or

dividends are logically circular simultaneities and thus

are fallacious, meaningless, non-interpretable,

indeterminate and not valid when tested and estimated

by scientific statistical methods

roblems wlLh MeLhodology

AnoLher paper (Paugen and Pelns 8lsk and

Lhe 8aLe of 8eLurn on llnanclal AsseLs Some

Cld Wlne ln new 8oLLles concluded 1he

resulLs of our emplrlcal efforL do noL supporL

Lhe convenLlonal hypoLhesls LhaL rlsk

sysLemaLlc or oLherwlse generaLes a speclal

reward

The Black-Jensen-Scholes (1972) Test

A. The errors-in-variables problem

1. f 5-10 years of data is used to estimate .

i

, the estimate is very noisy.

2. Using longer estimation period won't work because .

i

's change over

time.

3. Solution is to form portfolios, whose .

i

's can be estimated much

more precisely.

4. Problem is how to choose the composition of the portfolios:

f portfolios are formed randomly, portfolio .

i

's will all be close to 1, and

test will lack power.

Need a method to get sufficient variation in the portfolio .

i

's.

The Black-Jensen-Scholes Test

B. BJS Portfolio selection technique (slightly modified):

1. Each year, calculate .

i

's using a regression of each securities return on the

market for the past five years.

2. Form 10 portfolios based on estimated .

i

's

Smallest portfolio has the 10% of the stocks with the lowest estimated .

i

's, etc.

3. Re-estimate the portfolio .

i

's after the formation period.

The second regression:

gave

a

1

= 0.00359

a

2

= 0.01080

it t Mt i it

e R R a R R ) (

1

.

it i it

e a a R R .

2 1

Figure 15.2

Lxcess 8eLurn versus 8eLa

BJS Ex Post Security Market Line (SML)

ResuIts of the BJS Study

The results of the study appeared to be consistent with

the zero beta version of the Capital Asset Pricing Model

(CAPM):

f the standard CAPM was true they should have

found d

i

= 0 for all deciles (portfolios).

However, they found di negative (positive) for large

(small) betas. %his is consistent with the Zero-Beta

CAPM.

Also note that Black, Jensen, and Scholes, estimated

the ex post Security Market Lines in various sub-

periods. n general, the results were similar.

1esLs of lama and Mac8eLh

Sample: All stocks on the NYSE (1926 - 1968)

Market ndex: Equally weighted portfolio of all stocks on the NYSE.

OutIine of the Study

1. Estimate a beta for each stock using monthly returns during the period,

1926 - 1929, (i.e., 48 months).

2. Rank order all of the stock betas, and form 20

portfolios. The top 5% with the highest betas are in

portfolio #1, . . . etc. . . the bottom 5% with the

smallest betas are in portfolio #20.

3. Estimate the beta of each of the portfolios by regressing portfolio monthly

returns against the market index during the period, 1930 - 1934, (i.e., 60

months).

4. For each of the months during the period, 1935- 1938 estimate the ex

post SML by regressing portfolio returns against portfolio betas.

Note: 48 SMLs will be estimated (one for each month).

Summary of Steps 1 Through 4

1926 - 1929

Used to estimate

stock betas and

form 20 portfolios

1930 - 1934

Used to estimate

beta of each of

the 20 portfolios

1935 - 1938

Used to estimate

48 SMLs (One for

each month)

5. For each of the months during the period, 1935 - 1938, estimate two

additional equations:

stocks the oI variance residual Average

m

) (c o

RV : where

return portIolio aIIects stocks oI

variance residual her test whet to c RV a a a a r

ty nonlineari Ior test to c a a a r

m

1 j

j

2

p

p p 3

2

p 2 p 1 0 p

p

2

p 2 p 1 0 p

version of the CAPM:

a

0

was significantly greater than the mean of the

risk-free interest rate.

a

1

was significantly different from zero. The slope

of the SML was positive.

a

2

and a

3

were not significantly different from zero

(i.e., there was no evidence of nonlinearity or of

residual variance affecting returns).

Difference between BJS and FM Studies

n BJS, betas and average returns were computed

in the same periods.

n FM, betas in one period were used to predict

returns in a later period.

The FM Equation

0

0.1

0.2

0.3

0.4

0 0.2 0.4 0.6

r

j,t

= A

j

+ .

j

r

M,t

+1

j,t

r

j,t

r

M,t

.

j

Roll's Critique of Tests of the CAPM

Tests like those of BJS and FM are

tautological (not necessary). Results like

those reported could be obtained irrespective

of how securities were priced relative to risk.

(e.g., pulling numbers out of a hat would

produce the same results). Therefore, the

CAPM was not really tested. Furthermore,

since we cannot operationally define the

market portfolio, the CAPM can never be

tested.

t is true that if the market portfolio is efficient, the

relationship between expected return and beta will be

perfectly linear and positively sloped:

0

0.25

0 0.48

0

0.25

0 0.5 1 1.5

E(r)

E(r

M

)

E(r

z

)

E(r

M

)

E(r

z

)

E(r)

9(r)

.

SML

CML

M

C

B

A

C

M

B

A

However, given a linear relationship between portfolio

return and beta, it does not necessarily follow that the

market portfolio is efficient. Therefore, we have not tested

the CAPM.

For example, if betas are computed with

reference to an index portfolio inside the

minimum variance set, the relationship

between security betas and expected returns

will not be linear. Portfolios, however, will plot

closer to the SML because the security

residuals will be averaged in the portfolios.

Therefore, using an inefficient market portfolio

(M'):

(See the graphs that follow)

For ndividual Securities

0

0.25

0 0.48

0

0.25

0 0.5 1 1.5

E(r)

E(r

M

)

E(r

z

)

M

9(r)

E(r

M

)

E(r

z

)

.

E(r)

M'

For Portfolios

0

0.25

0 0.48

0

0.25

0 0.5 1 1.5

E(r)

E(r

M

)

E(r

z

)

M

9(r)

E(r

M

)

E(r

z

)

.

E(r)

M'

Empirical Evaluation of CAPM

WhaL can conclude Slnce mld1960s

- 5moll stocks bove ootpetfotmeJ lotqe stocks

- 5tocks wltb low totlos of motkettobook voloe

bove ootpetfotmeJ sLocks wlLh hlgh raLlos

1he relaLlonshlp beLween reLurn and beLa was

essenLlally flaL Lo negaLlve

1he |mpact of surv|va| b|as does not fu||y exp|a|n the

re|at|onsh|p found between performance and the

pr|ce to book va|ue rat|o

On the Other Hand . . Some Argued . . .

Fama and French study suffers from "survival

bias.

Many stocks with low ratios of price to

book value are in financial stress and wind

up failing. These stocks were excluded

from the Fama and French data. This

produced upward bias in the performance

of low price to book value stocks as a

class.

StiII Others Argued . . .

1he |mpact of surv|va| b|as does not fu||y exp|a|n the

re|at|onsh|p found between performance and the pr|ce

to book va|ue rat|o

Irrespect|ve of the pr|ce to book va|ue rat|o surv|va| b|as

cannot be used to exp|a|n the f|at to negat|ve

re|at|onsh|p between return and beta

Comment on Testing the CAPM

1he ev|dence d|scussed above does not prove

that the CAM |s |nva||d s|nce on|y stocks were

|nc|uded |n the ana|yses 1he "Market ortfo||o"

conta|ns a|| of the cap|ta| assets |n the un|verse

We w||| never be ab|e to observe the returns on

the "true" Market ortfo||o 1herefore the

CAM |s s|mp|y not a testab|e theory

Some Additional Evidence

Estimated betas are very sensitive to the

market index being used.

n risk-return space, indices can be close to

each other, and close to the efficient set, and

still produce different relationships (positive

and negative) between return and beta.

One study suggested using a dual beta

approach to adjust for risk differences in bull

and bear markets.

Some Conflicting Findings in Foreign Stock Markets

A slze effecL and a !anuary effecL exlsLed on Lhe

1okyo SLock Lxchange

lound a slgnlflcanL slze effecL on Lhe Mexlcan

SLock Lxchange

no slgnlflcanL slze effecL was found on Lhe

1oronLo SLock Lxchange

very llLLle slze effecL was found uslng AusLrallan

daLa

Empirical Evaluation of CAPM

Summary of CAPM

CAPM is attractive:

1. t is simple and sensible:

is built on modern portfolio theory

distinguishes systematic risk and non-systematic risk

provides a simple pricing model.

2. t is relatively easy to implement.

CAPM is controversial:

1. t is difficult to test:

difficult to identify the market portfolio

difficult to estimate returns and betas.

2. Empirical evidence is mixed.

3. Alternative pricing models might do better.

SUMMARY OF THE Empirical Study

The empirical studies generally agree upon the following results:

a) The intercept, d

1

, is significantly different from R

f

.

b) There are studies showing that when including other variables in

the regression, their coefficients are significantly different from zero.

c) f including a squared beta in the regression, its coefficient is not

significantly different from zero.

d) The coefficient of beta a

2

is less than Rm - Rf.

e) When the equation is estimated over long periods of time a

2

> 0.

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