Abstract
Since the inception of prospects theory of Markowitz (1952) which leads to the development of CAPM has been studied and applied in many ways. Some researchers conclude that CAPM is valid and could be used for valuation of securities and cost of equity. However, critiques arise that CAPM is a single risk factor and remark that a single factor model cannot be generalized in the overall capital markets because the capital market absorbs many other risk factors. The CAPM has been applied to the Pakistan’s Stock Exchange to check the validity of CAPM for a sample of 306 individual firms and 18 industrial portfolios. Two pass regression has been applied to check the applicability of CAPM in Pakistan’s stock exchange. The results show that CAPM, single factor model is not valid for the technical analysis in Pakistan's capital market. The investors need to use other type of factor models which include other economic and non economic kind of variables for valuation of securities.
Highlights
Investment in stock market has never been considered as free of risk
As the number of securities increases in portfolio it’s caused increasing the efforts to compute the number of portfolio risks
Based on the above scenario Capital Assets Pricing Model (CAPM) can be defined as a model that express the relationship between risk and expected required rate of return; in CAPM a security expected required rate of return is the risk free rate of return plus an equity premium based on the systematic risk of the security
Summary
Investment in stock market has never been considered as free of risk. The securities associated with risk have been always compensated for higher rate of return than those of the risk free investment. The risk of securities can be minimized through efficient diversification, which means two or more than two securities are combined in such a way to form an efficient portfolio. As the number of securities increases in portfolio it’s caused increasing the efforts to compute the number of portfolio risks. The technique which gains momentum and popularity for use in computing the relationship between portfolio risk and return is called CAPM. Based on the above scenario CAPM can be defined as a model that express the relationship between risk and expected required rate of return; in CAPM a security expected required rate of return is the risk free rate of return plus an equity premium based on the systematic risk of the security
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