A Study on Capital Asset Pricing Model with Different Approaches to Risk in Tehran Stock Exchange

Document Type : پژوهشی

Authors

• hamid Yari ¹
• arezo yari ²

¹ University of Tehran, Tehran, Iran

² bu-ali sina

https://doi.org/10.22067/pm.v23i11.19559

Abstract

In any market, knowing the best method of measuring risk can be very useful for investors and policymakers. In this regard, twenty of best seller corporations of Tehran Stock Exchange (TSE) were studied using monthly historical data (from April 2004 to March 2011). Several variations of the capital asset pricing model (CAPM), such as Lower Partial Moment-Capital Asset Pricing Model (LPM-CAPM), Asymmetric Response Model (ARM), and traditional CAPM were empirically tested. The results show that the traditional Capital Asset Pricing Model is the best model at the present period.

JEL Classification: G12, G32

Theoretical Framework
A plethora of empirical tests of the CAPM that implicitly assume the mean-variance based preference of the investors have been performed. However, statistical tractability of mean-variance analysis based on multivariate normality is a more important consideration in the development of the theory than the explicit recognition of investor preferences. Beginning from about the last quarter of the twentieth century, alternative theories based on different perceptions of systematic risk have challenged the dominance of the mean-variance notion of risk-return relationship. The most prominent of these is the asset pricing theory which recognizes risk as the deviation below a target rate of return. Downside risk measures and the associated asset pricing models are motivated by economic and statistical considerations; investor psychology is consistent with asymmetric treatment of the variations in the returns and empirical return distributions appear to be non-normal. Bawa and Lindenberg (1977) developed an asset pricing model, which we refer to as the mean-lower partial moment (MLPM) model, based on downside risk. In the MLPM model, risk is defined as the deviation below the risk-free rate. For normal and student-t-distributions of returns, the MLPM model reduces to the conventional CAPM. In the MLPM model, the downside beta simply replaces the CAPM beta. Bawa and Lindenberg (1977) argue that their model explains the data at least as well as the CAPM does. Harlow and Rao (1989) developed an asset pricing model in the downside framework that is more general in that the risk is defined as the deviation below an arbitrary target rate.

Methodology
Twenty of best seller corporations of Tehran Stock Exchange (TSE) were studied using monthly historical data (from April 2004 to March 2011). Several variations of the capital asset pricing model (CAPM), such as Lower Partial Moment-Capital Asset Pricing Model (LPM-CAPM), Asymmetric Response Model (ARM) and traditional CAPM, were empirically tested.

Results and Discussion
The results show that, traditional Capital Asset Pricing Model, is better than Lower Partial Moment-Capital Asset Pricing Model (LPM-CAPM) and Asymmetric Response Model (ARM) in our selected period (from April 2004 to March 2011).

Conclusions and Suggestions
The results show that despite some empirical tests in recent years, it seems that by using long samples, traditional CAPM model could be a reliable test. Finally, authors suggest that to achieve more reliable results in CAPM models, researchers have to consider environmental conditions to use the best model.

Keywords

• Risk
• Lower Partial Moment-Capital Asset Pricing Model (LPM-CAPM)
• Asymmetric Response Model (ARM)
• Tehran Stock Exchange

References

[1] Raai, R., & Saeedi, A. (2006). Basics of financial engineering and risk management (2nd ed.). Tehran: University of Tehran's Publications. (In Persian)

[2] Raai, R., & Khosravi, A. R. (2007). Explanation of capital asset pricing model with risk-adverse approach in Tehran Stock Exchange. Journal of Humanities and Social Sciences, 26, 46-63 (In Persian)

[3] Sadeghi, M., Sorosh, A., & Farhanian, M. J. (2010). Investigating the volatility, upside risk, downside risk and Capital Asset Pricing Model: Evidences from Tehran Stock Exchange. Financial Research, 12(29), 59-79. (In Persian)

[4] Sadeghi Sharif, S. J. (2003). Capital asset pricing model design in Tehran Stock Exchange (Unpublished doctoral dissertation). University of Tehran, Tehran. (In Persian)

[5] Ang A., Chen, J., & Xing, Y. (2002). Downside risk & the momentum effect. NBER Working Paper Series, No. 8643. Retrieved from http://www.nber.org/papers/w8643.

[6] Bawa, V., & Lindenberg, E. (1977). Capital market equilibrium in a mean-lower partial moment framework. Journal of Financial Economics, 5, 189-200.

[7] Bawa, V., Brown, S., & Klein, R. (1981). Asymmetric response asset pricing models: Testable alternatives to mean-variance. Mimeo.

[8] Bekaert, G. (1995). Market integration and investment barriers in emerging equity markets. World Bank Economic Review, 9, 75-107.

[9] Bekaert, G., & Harvey, C. (1995). Time-varying world market integration. Journal of Finance, 50, 403-444.

[10] Bekaert, G., Harvey, C., & Lumsdaine, R. (2002). The dynamics of emerging market equity flows. Journal of International Money and Finance 21(3), 295-350.

[11] Don U., Galagedera, A. (2007). An alternative perspective on the relationship between downside beta and CAPM beta. Emerging Market Review, 8, 4-19.

[12] Eftekhari, B., & Satchell, S. (1996). Non-normality of returns in emerging markets. Research in International Business and Finance, 1, 267-277.

[13] Estrada, J. (2000). The cost of equity in emerging markets: A downside risk approach. Emerging Markets Quarterly, 4, 19-30.

[14] Estrada, J. (2002). Systematic risk in emerging markets: The D-CAPM. Emerging Market Review, 3, 365-379.

[15] Estrada, J. (2007). Mean-Semi variance behavior: Downside risk and capital asset pricing. International Review of Economics and Finance, 16, 169-185.

[16] Fabozzi, F. and J, Francis, (1977), Stability tests for alphas and betas over Bull and Bear market conditions, Journal of Finance 32, 1093-1099.

[17] Fama, E. F. and French, K. R. (1992). The cross-section of expected stock returns. Journal of Finance, 47(2), 427-466.

[18] Harlow, W., & Rao, R. (1989). Asset-pricing in a generalized mean-lower partial moment framework: Theory and evidence. Journal of Financial and Quantitative Analysis, 24, 285-311.

[19] Harvey, C. (1995). Predictable risk and returns in emerging markets. Review of Financial Studies, 8, 773-816.

[20] Hawng, S., & Pedersen, C. S. (2002). Best practice risk measurement in emerging markets: Empirical test of asymmetric alternatives to CAPM. Case Business school, Working Paper,UK.

[21] Mohammadi, Sh., Abbasi nejad, H., Mirsaneei, S. R., (2007), Examination of BETA estimation Methods in Tehran Stock Exchange. The Iranian Accounting and Auditing Review, 47, 3-38. (In Persian)

[22] Homaifar, G., & Graddy, D. B. (1990). Variance and lower partial moment betas as alternative risk measures in cost of capital estimation: a defense of the CAPM beta. Journal of Business Finance Account, 17:5, 677-688

[23] Hogan, W., & Warren, J. (1974). Toward the development of equilibrium capital market model based on semi variance. Journal of Financial and Quantitative Analysis, 9, 1-11.

[24] Jagannathan, R., & McGrattan, E. (1995). The CAPM debate. Federal Reserve Bank of Minneapolis Quarterly Review, 19, 2-17.

[25] Kim, M., & Zumwalt, J. (1979). An analysis of risk in Bull and Bear markets. Journal of Financial and Quantitative Analysis, 14, 1015-1025.

[26] Lintner, J. (1965). The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets. Review of Economics and Statistics, 47, 13-37.

[27] Nantell, T. J., & Price, B. (1979). An analytical comparison of variance and semi variance capital market theories. Journal of Financial and Quantitative Analysis, 14(2), 221-242.

[28] Pedersen, C. & Satchell, S. (2000). Small sample analysis of performance measures in the asymmetric response model. Journal of Financial and Quantitative Analysis, 35(3), 425-450.

[29] Pedersen, C. & Satchell, S. (2002). On the foundation of performance measures under asymmetric returns. Quantitative Finance, 3, 217-223.

[30] Sharpe, W. (1963). A simplified model for portfolio analysis. Management Science, 9(2), 277-293.

[31] Shaun, A. B., & Kanak, P. (2002). The conditional distribution of real estate returns: Are higher moments time varying?" Journal of Financial Economic, 26 (2), 319-339