Conditional Capital Asset Pricing Model: A Case of Pakistan's Equity Market

Abstract

This research was aimed towards investigating the validity and applicability of Capital Asset Pricing Model (CAPM), in which risk and return relationship is determined, in the context of Pakistan’s Stock Market. One of the most appropriate methods employed by investors, portfolio managers and financial economists to verify pricing of the securities and the expected returns given the risks is the Capital Asset Pricing Model (CAPM). Taking different dimensions of CAPM, conditional CAPM, is highly essential specially with regard to having a portfolio in equity markets of developing countries such as Pakistan. Background of the model was presented and research work of other researchers in the same field has been discussed. The effect of conditional CAPM in Karachi Stock exchange (KSE), Pakistan’s equity market, was studied to see model’s usage in highly volatile markets such as the Karachi Stock Exchange (KSE). Empirical test were conducted on data of actively traded 100 companies in Karachi stock exchange (KSE-100 index). The selected companies represented all the sectors of Pakistan. These 100 companies were distributed to 10 portfolios in descending order according to their monthly returns over the time span of 118 months. GARCH and GARCH-M were applied to the portfolios to derive the empirical results.