An Evaluation Of Capital Asset Princing Model In The Indian Context

The book evaluates the univariate and multivariate Capital Asset Pricing Models in the Indian capital market. The book has been written to meet the requirement of management students, researchers, academic scholars, policy makers, financial analyst etc. CAPM is widely used in finance literature. This theory is gaining momentum in the developed as well as emerging economies. Therefore, there is a need for research in the area of asset pricing in the financial markets. The book has been written in a student and researchers friendly way. The salient features of the book are extensive coverage of the following features: Portfolio investment process, capital market line, security market line, CAPM, Empirical studies on CAPM in developed capital markets and in the Indian capital markets; an overview of the Indian capital market. Empirical results and discussions of the univariate and multivariate CAPM models. Implication of the book: the empirical findings of this book would be useful to financial analysts as the results prove that the CAPM with multifactor is useful in determining security/market value weighted portfolio returns in the Indian capital market"

Examining the Capital Asset Pricing Model (CAPM) in the Indian Capital Market Some authors argue that not only the most discerning investor cannot establish the composition of the true market portfolio, but there is also no reason to assume that systematic risk is the sole factor affecting a security's expected return. This study aims to examine whether the standard Capital Asset Pricing Model (CAPM) by Sharpe (1964) and Lintner (1965) holds in the Indian capital market. Introducing the Topic and Key Assumptions Chapter 1 introduces the topic, emphasizing the concept and importance of CAPM in the Indian context. The basic tenet of the CAPM model summarizes the following assumptions: Investors are risk-averse and prefer expected returns while avoiding risk. Investors base investment decisions on expected returns and the variances of security returns. Investors behave normatively and aim to hold a portfolio along the efficient frontier. A riskless asset exists, allowing investors to lend or invest at the riskless rate and borrow at this rate at any moment. All investments are perfectly divisible, meaning that every security and portfolio is equivalent to a mutual fund, and fractional shares can be purchased in any amount. All investors have homogeneous expectations regarding investment horizons, holding periods, forecasted expected returns, and risk levels on securities. Reviewing the Literature and Methodological Issues Chapter Two of this study reviews the literature on the CAPM model, dividing it into three broad headings: A. Methodological issues influencing empirical methods. Exploring the Theory of CAPM Chapter three of the study explores the Theory of CAPM. In finance, the Capital Asset Pricing Model (CAPM) determines a theoretically appropriate required rate of return for an asset, assuming it is added to a well-diversified portfolio. The model considers the asset's sensitivity to non-diversifiable risk, often represented by the quantity beta (β), the expected return of the market, and the expected return of a theoretical risk-free asset. CAPM suggests that an investor's cost of equity capital is determined by beta. Despite its empirical shortcomings and the presence of more modern approaches to asset pricing and portfolio selection, such as arbitrage pricing theory and Merton's portfolio problem, the CAPM remains popular due to its simplicity and utility in various situations.

Generous consideration has been pursued to the empirical testing of multi factor assets pricing models. However, literature provides mixed kind of evidences in the support of multi factor assets pricing model. This study reviews 20 research articles based on multi factor assets pricing model and examines 25 research papers based on the empirically testing of multi factor assets pricing model published during 2001 and 2018 to study the multi factor assets pricing model in the Indian context as well as foreign context. CAPM is a popular normative model used by researchers to explain the relationship between risk and expected return of a risky asset which was developed by Sharpe (1964) and Lintner (1965). This model takes only one risk factor which is the excess market portfolio return (Market premium). Because of poor performance of CAPM in explaining realized returns, the Fama and French three factor asset pricing model (1993) was developed. Fama and French (1993) documented the size effect and the value effect that were not included in the CAPM, generally known as CAPM anomalies. Mark M. Carhart (1997) developed the Carhart four factor model. It is an extension of the FF three factor model with one another factor i.e. momentum factor effect for asset pricing of stocks. In view of the limitations of the earlier three-factor model, Fama and French five-factor asset pricing model (2014) was developed. Fama and French (2014) came with profitability pattern and investment pattern in average stock return along with the market premium, size premium and value premium. This paper may be an expedient source of information to the academics, financial analyst and researchers to understand the asset pricing model.

"This book empirically shows that the multi-factor asset pricing models, like the Fama-French model, provide a better description of average stock returns compared to the more widely accepted capital asset pricing model (CAPM). It is suggested that the market practitioners should re-design their investment management tool box by replacing CAPM with the Fama-French model for industry applications such as cost of capital estimation, corporate valuation, estimating fair rates of return, assessing stock market efficiency and portfolio performance evaluation. It is also revealed that size-based, value-based, reversal-based and momentum-based trading strategies do not provide extra-normal returns in India. The book will be a useful reference for mutual fund managers, portfolio managers, financial consultants and investors at large. Academicians and students in the area of investment management and corporate finance can also benefit from it."

The problem addressed in this dissertation research was the inability of the single-factor capital asset pricing model (CAPM) to identify relevant risk factors that investors consider in forming their return expectations for investing in individual stocks. Identifying the appropriate risk factors is important for investment decision making and is pertinent to the formation of stocks' prices in the stock market. Therefore, the purpose of this study was to examine theoretical and empirical validity of the CAPM and to develop and test a multifactor model to address and resolve the empirical shortcomings of the single-factor CAPM. To verify the empirical validity of the standard CAPM and of the multifactor model, five hypotheses were developed and tested against historical monthly data for U.S. public companies. Testing the CAPM hypothesis revealed that the explanatory power of the overall stock market rate of return in explaining individual stock's expected rates of return is very weak, suggesting the existence of other risk factors. Testing of the other hypotheses verified that the implied volatility of the overall market as a systematic risk factor and the companies' size and financial leverage as nonsystematic risk factors are important in determining stock's expected returns and investors should consider these factors in their investment decisions. The findings of this research have important implications for social change. The outcome of this study can change the way individual and institutional investors as well as corporations make investment decisions and thus change the equilibrium prices in the stock market. These changes in turn could lead to significant changes in the resource allocation in the economy, in the economy's production capacity and production composition, and in the employment structure of the society.

Capital Asset Pricing Model (CAPM) is the fundamental model for asset pricing. In addition to the systematic risk, various factors (size effect, leverage effect, E/P ratio effect, liquidity effect, etc.) have been considered to explain asset pricing in the recent and advanced models (like Fama-French model and Carhart model). This paper provides a new factor of industry effect in addition to several other factors explained in the past. In this paper, the dummy variable regression method is used, which helps in explaining the service and non-service industry effect on asset pricing. The sample of this study contains daily return of 290 stocks of NSE CNX 500 index for 10 years. For correction of nonsynchronous trading error in the beta, the adjusted beta calculated with the help of Dimson model is used. The analysis is conducted separately for before the financial crisis and after the financial crisis. This study confirms the presence of industry effect in the return generating process of stocks in the Indian equity market. The study elaborates the interactive effect of beta and industry factor.

Though it is commonly said that higher the risk higher would be the returns, the questions that remain are, what type of risks are awarded and what is risk premium per unit of risk. A few equilibrium asset-pricing models attempted to answer these questions. Out of these, Capital Asset Pricing Model (CAPM) is the most popular and widely used model. It was independently developed by Sharpe (1964), Lintner (1965), and Mossin (1966). Fama (1968), Black, Jensen and Scholes (1972), Fama and Mac Beth (1973), and Fama and French (1992) and others proposed further refinements. The CAPM provides a precise prediction of the relationship between the risk of an asset and its expected return. In the Indian stock market the empirical studies on CAPM showed mixed results. Roll's critique has attracted attention of many researchers and resulted in popular articles such as “Is Beta Dead?” “Is Beta Dead or Alive?” “Are Reports of Beta's Death Premature? “Is Beta Dead Again?” that effectively reduced the popularity of CAPM in the world of finance in 1992. The debate regarding superiority of Asset Pricing Theory (APT) to CAPM is continuing. The empirical testing of APT is still in its early stage and concrete results in favour of APT or against CAPM do not exist. Till then, CAPM is expected to dominate the capital market as a measure to ascertain expected returns of risky securities.

The arbitrage pricing theory (APT) has been proposed as an alternative to the capital asset pricing model (CAPM). This paper uses principal components analysis to estimate the factors that influence stock returns. Analysis of the Indian stock market using monthly and weekly returns for 1991-2002 shows that APT with multiple factors provides a better indication of asset risk and estimates of required rate of return than CAPM which uses beta as the single measure of risk.