Academic journal article Asian Social Science

Verifying Capital Asset Pricing Model in Greek Capital Market

Academic journal article Asian Social Science

Verifying Capital Asset Pricing Model in Greek Capital Market

Article excerpt


This article deals with capital asset valuation on Greek capital market using Capital Asset Pricing Model (CAPM). We examined 32 companies listed on the Athens Stock Exchange on a weekly basis for a period from June 2009 to December 2013 under this model. The CAPM model is tested by performing two-pass characteristic regression analyses. The first-pass characteristic line regression was used to estimate stocks of beta. Hence, the second-pass characteristic line regression was taken to analyze the intercept and the slope coefficients of stocks. The two characteristics of line regression verify the adequacy of the CAPM. According to our results, we came to a conclusion that there was a linear relationship between systematic risk and returns. The CAPM would be the verification of our major hypotheses from the time series tests. In order for this to be true, the intercept ought to be approximately equal to zero, supporting the theories for both individual assets and portfolios. However, the testing provides evidence against the CAPM, but do they do? It should be kept in mind that it does not necessarily represent evidence in favor of any alternative model.

Keywords: CAPM, coefficient Beta, securities market portfolio, systematic risk, market risk premium

1. Introduction

The CAPM (capital asset pricing model) is useful as a decision-support tool for corporate finance. Firms need to estimate their cost of capital to evaluate new investment projects that are considered capital budgeting decisions. For this reason, financial managers can use the CAPM to calculate the cost of their equity.

The CAPM is established on the basis of the modern theory of Markowitz portfolios. This type of CAPM was developed using a theory of modern portfolios by William F. Sharp (1963 and 1964) and John Linter. William F. Sharp was awarded the Nobel Prize. This CAPM is based on the assumption of positive risk-return trade-offs. The theory affirms that the expected return on every asset is a positive function of only one variable: its market beta (defined as the covariance of asset return and market return). The CAPM, being a theoretical model, is based on some key assumptions:

§ All investors look at only one-period expectations about the future;

§ Investors are price takers, and they cannot influence the market individually;

§ There is a risk-free rate for which any investor lends or borrows money;

§ Investors are risk-averse;

§ Taxes and transaction costs are irrelevant.

One of the major results of the CAPM is the proof of the relationship between expected risk premiums on special assets and their "systematic risk." This relationship shows that the expected return on every asset is directly proportional to its "systematic risk." This study aims to test the standard form of the CAPM in the Greek capital market. The study was divided into four parts. The first part represents the introduction, and the next part reviews some of the empirical evidences on the CAPM. The third part considers the CAPM for methodology application and data selection. The last contains a verification of the CAPM and analysis of the results. Finally, a summary and some conclusions will be given.

2. Literature Review

The CAPM built on the model of choice was developed by Markowitz (1959) and Tobin (1958). They developed the "risk-return portfolio theory" based on the benefits model of von Neumann and Morgenstern (1953). The model assumes that investors are risk-averse when choosing among portfolios. Markowitz selected the "mean-variance-efficient" stock portfolios to be used in his model. After that, the CAPM model was developed independently by Sharpe (1964), Linter (1965), and Mossin (1966). They added two fundamental hypotheses to the Markowitz model to determine one portfolio that must be mean-variance-efficient. The development of the Sharpe-Lintner version of the CAPM is to use the assumption of risk-free borrowing and lending the expected return on zero-beta assets. …

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