Is traditional CAPM a good measure for risk and return in kse

Abstract

Although there are overabundance of asset pricing models developed by many researchers in order to illuminate the cross sections among asset returns, though, all these models entails perfect market conditions that entirely exists in the developed markets of world. The aim of contemporary study is to examine the empirical validity and applicability of traditional capital asset pricing model (CAPM) in enlightening the cross sections of returns on stock in the contextual framework of developing equity market of Pakistan i.e. KSE. In order to empirically analyse the CAPM, a sample of 70 stocks were undertaken that comprises of 11 different sectors listed on KSE while KSE-100 index was taken as a proxy for market portfolio. In order to obtain better results, monthly data was obtained for the variables used in the current study for a sample period of 5 years commencing January 2009 to December 2013. While for risk free rate, rate on six month Treasury bill was obtained as proxy for risk free rate. For empirical analysis of traditional capital asset pricing model, techniques of time series regression and cross sectional regression are applied to examine the cross sections of stock returns listed in KSE. The findings of the current study on empirical validity of traditional CAPM are inconclusive. Findings of the study suggests that traditional CAPM fails to explain the cross sections of stock returns in KSE on the whole. The empirical findings of the study exhibited statistically insignificant intercept term which indicates the absence of regular mispricing of stocks listed in KSE over a sample period. But the findings of the current study revealed statistically no significant results for the risk premium grossed for undertaking systematic risk over the sample period as illustrated in traditional CAPM. Grounded on the key findings of the current study, it is revealed that traditional CAPM is not empirically validated in KSE. Therefore, findings implies that KSE may be considered as inefficient equity market which doesn’t deliver rational trade-off among risk and return. So, findings implies that if investors uses the traditional CAPM for the formation of diversified portfolio than that may result in losses and poor investment performance. So, investors are advised to attain and analyze the evidence that is accurate, adequate and timely.