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1 – 10 of over 1000Yifan Chen, Zilin Chen and Huoqing Tang
The purpose of this paper is to introduce an augmented high-order capital asset pricing model (AH-CAPM) as a new risk-based model to price stocks.
Abstract
Purpose
The purpose of this paper is to introduce an augmented high-order capital asset pricing model (AH-CAPM) as a new risk-based model to price stocks.
Design/methodology/approach
The AH-CAPM is defined as a linear model with high-order marginal moments and co-moments from the joint distributions of the sorted stock portfolio returns and the market return.
Findings
The performance of the AH-CAPM is tested in the Chinese and US stock markets. Empirical results show that the high-order marginal moments and co-moments from the joint distributions in AH-CAPM contain the risk and return information implied by the Fama–French factors, indicating it as a better risk measurement. Moreover, the AH-CAPM performs better than the Fama–French three-factor model and the Carhart four-factor model in both the Chinese and US stock markets.
Originality/value
Overall, this study introduces a new asset pricing model with better measurements to incorporate risk information in the stock market.
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Mohamad Hafiz Hazny, Haslifah Mohamad Hasim and Aida Yuzy Yusof
The capital asset pricing model (CAPM) is the most widely used asset pricing model that measures risk–return relationship. The CAPM is based on Markowitz’s mean variance analysis…
Abstract
Purpose
The capital asset pricing model (CAPM) is the most widely used asset pricing model that measures risk–return relationship. The CAPM is based on Markowitz’s mean variance analysis. The advancement of Islamic finance leads to the question whether or not the practice of modern investment theories and analyses such as the Markowitz’s mean variance analysis and CAPM are in accordance to shariah and could be used in pricing Islamic financial assets. Therefore, this paper aims to present a review of the CAPM and to discourse the set of assumptions underlying the model in terms of shariah compliance.
Design/methodology/approach
Although most of the assumptions are not contradictory to shariah principles, there are Islamic variables such as prohibition of short selling, purification and zakat that should be taken into consideration when pricing Islamic financial assets. We then develop a mathematical model which is a modification of the traditional CAPM that incorporates principles of Islamic finance and integrating zakat, purification of return and exclusion of short sales.
Findings
As a proof-of-concept, this paper presents the results of an empirical study on the proposed shariah-compliant CAPM in comparison to the traditional CAPM. The results show that the proposed Islamic CAPM is appropriate and applicable in examining the relationship between risk and return in the Islamic stock market.
Originality/value
This study contributes to existing body of knowledge by presenting an algorithm and mathematical derivation of the shariah-compliant CAPM which has been lacking in the literature of Islamic finance. The paper offers a novel approach in pricing Islamic financial assets in accordance to shariah, advocated by modern investment theories of Markowitz’s mean variance analysis and CAPM.
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The main aspect of security analysis is its valuation through a relationship between the security return and the associated risk. The purpose of this paper is to review the…
Abstract
Purpose
The main aspect of security analysis is its valuation through a relationship between the security return and the associated risk. The purpose of this paper is to review the traditional capital asset pricing model (CAPM) and its variants adopted in empirical investigations of asset pricing.
Design/methodology/approach
Pricing models are discussed under five categories: the single‐factor model, multifactor models, CAPM with higher order systematic co‐moments, CAPM conditional on market movements and time‐varying volatility models.
Findings
The paper finds that the last half‐century has witnessed the proliferation of empirical studies testing on the validity of the CAPM. A growing number of studies find that the cross‐asset variation in expected returns cannot be explained by the systematic risk alone. Therefore a variety of models have been developed to predict asset returns.
Research limitations/implications
There is no consensus in the literature as to what a suitable measure of risk is, and consequently, as to what is a suitable measure for evaluating risk‐adjusted performance. So the quest for robust asset pricing models continues.
Originality/value
From its beginning to its possible demise the paper reviews the history of the CAPM assuring that we are all up to speed with what has been done.
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Mehmet Emin Yildiz, Yaman Omer Erzurumlu and Bora Kurtulus
The beta coefficient used for the cost of equity calculation is at the heart of the valuation process. This study conducts comparative analyses of the classical capital asset…
Abstract
Purpose
The beta coefficient used for the cost of equity calculation is at the heart of the valuation process. This study conducts comparative analyses of the classical capital asset pricing model (CAPM) and downside CAPM risk parameters to gain further insight into which risk parameter leads to better performing risk measures at explaining stock returns.
Design/methodology/approach
The study conducts a comparative analysis of 16 risk measures at explaining the stock returns of 4531 companies of 20 developed and 25 emerging market index for 2000–2018. The analyses are conducted using both the global and local indices and both USD and local currency returns. Calculated risk measures are analyzed in a panel data setup using a univariate model. Results are investigated in country-specific and model-specific subsets.
Findings
The results show that (1) downside betas are better than CAPM betas at explaining the stock returns, (2) both risk measure groups perform better for emerging markets, (3) global downside beta model performs better than global beta model, implying the existence of the contagion effect, (4) high significance levels of total risk and unsystematic risk measures further support the shortfall of CAPM betas and (5) higher correlation of markets after negative shocks such as pandemics puts global CAPM based downside beta to a more reliable position.
Research limitations/implications
The data are limited to the index securities as beta could be time varying.
Practical implications
Results overall provide insight into the cost of equity calculation and emerging market assets valuation.
Originality/value
The framework and methodology enable us to compare and contrast CAPM and downside-CAPM risk measures at the firm level, at the global/local level and in terms of the level of market development.
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Steven A. Dennis, Prodosh Simlai and Wm. Steven Smith
Previous studies have shown that stock returns bear a premium for downside risk versus upside potential. We develop a new risk measure which scales the traditional CAPM beta by…
Abstract
Previous studies have shown that stock returns bear a premium for downside risk versus upside potential. We develop a new risk measure which scales the traditional CAPM beta by the ratio of the upside beta to the downside beta, thereby incorporating the effects of both upside potential and downside risk. This “modified” beta has substantial explanatory power in standard asset pricing tests, outperforming existing measures, and it is robust to various alternative modeling and estimation techniques.
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William Coffie and Osita Chukwulobelu
Purpose – The purpose of this chapter is to examine whether or not the Capital Asset Pricing Model (CAPM) reasonably describes the return generating process on the Ghanaian Stock…
Abstract
Purpose – The purpose of this chapter is to examine whether or not the Capital Asset Pricing Model (CAPM) reasonably describes the return generating process on the Ghanaian Stock Exchange using monthly return data of 19 individual companies listed on the Exchange during the period January 2000 to December 2009.
Methodology/approach – We follow a methodology similar to Jensen (1968) time series approach. Parameters are estimated using OLS. This study is designed to measure beta risk across different times by following the time series approach. The betas of the individual securities are estimated using time series data of the excess return version of the CAPM.
Findings – Our test results show that although market beta contributes to the variation in equity returns in Ghana, its contribution is not as significant as predicted by the CAPM, and in some cases very weak. Our results also reject the strictest form of the Sharpe–Lintner CAPM, but we found positive linear relationship between equity risk premium and market beta. Instead, our evidence uphold the Jensen (1968) and Jensen, Black, and Scholes (1972) versions of the CAPM.
Research limitations/implications – This study is limited to the single-factor CAPM. Future studies will extend the test to include both size and BE/ME fundamentals and factors relating to P/E ratio, momentum and liquidity.
Practical implications – Our results will make corporate managers to be cautious when using CAPM as a basis to determine cost of equity for investment appraisal purposes, and fund managers when evaluating asset and portfolio performance.
Originality/value – The CAPM is applied to individual securities instead of portfolios, since the model was developed using information on a single security.
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The underlying principle of the Capital Asset Pricing Model (CAPM) is that there is a linear relationship between systematic risk, as measured by beta, and expected share returns…
Abstract
The underlying principle of the Capital Asset Pricing Model (CAPM) is that there is a linear relationship between systematic risk, as measured by beta, and expected share returns. The CAPM attempts to describe this relationship by using beta to explain the differences between the expected returns on various shares and share portfolios. The CAPM has been the subject of considerable theoretical investigation and empirical research. The aim of this article is to establish the current knowledge of the usefulness of the CAPM, i.e. whether it provides a reasonable description of reality and whether it is a useful tool for investment decision‐making. The main conclusion drawn from the study is that the CAPM is useful and that it does describe and explain the risk/return relationship. However, other risk factors (i.e. other than beta) may also be useful for explaining share returns. Investors should therefore be cautious when using the model to evaluate investment performance.
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Tienyu Hwang, Simon Gao and Heather Owen
There has been considerable debate on the linear relationship between systematic risk and return. The purpose of this study is to investigate whether security return can be…
Abstract
Purpose
There has been considerable debate on the linear relationship between systematic risk and return. The purpose of this study is to investigate whether security return can be explained by systematic risk.
Design/methodology/approach
This study employs the market model to test the effect of excess return on portfolio returns. The paper divides total risk into systematic and idiosyncratic risk to examine whether the degree of inefficient portfolio diversification impairs the applicability of the capital asset pricing model (CAPM). In the two‐pass cross‐sectional regressions, the paper assesses whether excess return on a security is directly proportional to the security's beta. The paper also incorporates the total variance of securities and the squared value of beta to capture idiosyncratic risk and the nonlinear risk‐return relationship.
Findings
The CAPM is rejected due to positive intercepts in most portfolios and there are large proportions of idiosyncratic risk in these portfolios. Two‐pass regressions show that the security market line theory is valid when additional variables are included in the equation. However, survivorship bias appears to be present in the selected sample.
Practical implications
Since large excess returns are present in the models, the traditional CAPM is rejected and incomplete portfolio diversification can be explained by high levels of idiosyncratic risk.
Originality/value
The authors find that inefficient portfolio diversification is due to the level of idiosyncratic risk in a portfolio. Evidence of the nonlinear beta‐return relationship suggests that the traditional CAPM is misspecified.
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Salman Ahmed Shaikh, Mohd Adib Ismail, Abdul Ghafar Ismail, Shahida Shahimi and Muhammad Hakimi Mohd. Shafiai
This paper aims to study the cross section of expected returns on Shari’ah-compliant stocks in Pakistan by using single- and multi-factor asset pricing models.
Abstract
Purpose
This paper aims to study the cross section of expected returns on Shari’ah-compliant stocks in Pakistan by using single- and multi-factor asset pricing models.
Design/methodology/approach
To estimate cross section of expected returns of Shari’ah-compliant stocks, the study uses capital asset pricing model (CAPM), Fama-French three-factor model and Fama-French five-factor model. Data for the period 2001-2015 on 217 companies are used. For the market portfolio, PSX-100 and Dow Jones Islamic Index for Pakistan are used.
Findings
The study could not find empirical support for CAPM using Lintner (1965), Black et al. (1972) and Fama and Macbeth (1973) approach. Nonetheless, the relation between beta and returns is positive in up-market and negative in down-market. The results of Fama-French three-factor and five-factor models suggest that size premium is positive and significant for explaining the cross section of stock returns of small size stocks, whereas value premium is positive and significant for explaining the cross section of returns of high value stocks.
Practical implications
The results suggest that fund managers can use Shari’ah-compliant stocks for portfolio diversification and for offering specialized investments given the positive market excess returns and the existence of size and value premium on Shari’ah-compliant stocks.
Originality/value
This is the first study on Fama-French (2015) five-factor model for Islamic capital markets in Pakistan.
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Andres Bello, Jan Smolarski, Gökçe Soydemir and Linda Acevedo
The purpose of this paper is to investigate to what extent hedge funds are subject to irrationality in their investment decisions. The authors advance the hypothesis that…
Abstract
Purpose
The purpose of this paper is to investigate to what extent hedge funds are subject to irrationality in their investment decisions. The authors advance the hypothesis that irrational behavior affects hedge fund returns despite their sophistication and active management style.
Design/methodology/approach
The irrational component may follow a pattern consistent with the observed hedge fund returns yet far distant from market fundamentals. The authors include factors beyond the original version of capital asset pricing model such as Fama and French and Carhart models, as well as less stringent models, such as APT and Fung and Hsieh, to test whether these models are able to capture the irrational nature of the residuals.
Findings
After finding that institutional irrational sentiments play a role in hedge fund returns, we note that the returns are not completely shielded against irrational trading; however, hedge fund returns appear to be affected only by the irrational component derived from institutional trading rather than that emanated from individuals.
Research limitations/implications
Different sources of irrationality may have asymmetric effects on hedge fund returns. Using a different set of sophisticated investors along with different market sentiment proxies may yield different results.
Practical implications
The authors argue that investors can use irrational beta to gauge the extent of institutional irrational sentiments prevailing in markets for the purpose of re-adjusting their portfolios and therefore use the betas as an early warning sign. It can also guide investors in avoiding funds and strategies that display greater irrational behavior.
Originality/value
The study advance the idea that the unexpected, hereafter irrational, component may follow a pattern consistent with the observed hedge fund returns, yet different from market fundamentals.
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