Abstract:
To understand risk return relation, many researchers have created different sort of
models, each having its own set of assumptions and varied risk factors involved in the
analysis to postulate about the best results. These models are a fruitful way for investors
to analyze any investment beforehand to identify the “complicated risk return
relationship” and investigate the returns which they might be expecting from that
particular stock with said percent of risk. Basically investors always want to explore the
risk factors associated with any stock in order to get the desired outcome and earnings
return from that specific asset. Amongst all these models, Capital asset Pricing Model
(CAPM) stand out as one of the most usable and extensive choice which estimates the
anticipated return with respect to the risk inherent in the stock.
Basic aim of this study is to investigate the validity of Capital Asset Pricing Model in
stocks on the basis of market capitalization. For this 20 companies are selected out of
KSE 100 index. 10 companies having large capitalization stocks while other 10 consist of
small capitalization stocks. Monthly data of 5 years from 2009-2013 is collected
regarding stock prices of these companies. Market portfolio is constructed from KSE 100
index while rate on treasury bills was used for the calculation of monthly risk free rate.
Time series as well as cross sectional regression is used to empirically examine the
validity of capital asset pricing model in small and large capitalization stocks.
When investigated empirically findings of the study showed that capital asset pricing
model does not hold in Karachi stock exchange. The model failed to conclusively define
the relationship between risk and return in both small capitalization stocks as well as
large capitalization stocks. On the basis of findings of the study, it is revealed that
systematic risk is not the only factor affecting the return on stocks. So investment decision
based on capital asset pricing model will mislead the investors when it comes to invest in
either small capitalization stocks or large capitalization stocks.
