Capital Asset Pricing Model Framework Research Articles

The effect of structural oil shocks on stock returns of Indian renewable energy companies across market conditions

Purpose This study aims to evaluate the structural oil shocks effect on stock returns of Indian renewable energy companies across market conditions. Design/methodology/approach This study applies the structural vector autoregression model to estimate sources of oil shocks such as oil supply shock, aggregate demand shock and oil price-specific demand shock. In the next step, the panel quantile regression model estimates the effect of these oil shocks on stock return across market conditions. Monthly data are collected from January 2009 to December 2019. All renewable energy companies listed on the National Stock Exchange of India are considered for the analysis. Findings In the whole sample analysis, this study finds that oil shocks negatively affect stock returns in most of the market conditions except oil price-specific demand shock. In sub-groups, oil shocks driven by supply and aggregate demand also negatively affect stock return in most market conditions. This study finds the positive interaction of oil price-specific demand shock. A majority of these positive interactions happen in bearish market conditions. In the whole sample, the asymmetric effects of shocks driven from oil supply and oil price-specific demand are seen in most quantiles or market conditions. At the same time, aggregate demand shock does not affect asymmetrically. In the sub-group analysis, standalone renewable energy companies stock returns are least asymmetrically affected by these oil shocks. The asymmetries of oil supply-driven shock on stock returns of the renewable energy sub-group companies are found in most quantiles. Originality/value First, this is a company-level study of the stock returns response to the structural oil shocks in the renewable energy sector. Second, to the best of the authors’ knowledge, this type of study is the first in the Indian context. Third using panel quantile regression model along with capital asset pricing model framework, the authors investigate these effects across market conditions.

Capital Asset Pricing Model (CAPM) 2.0: Account of Business and Financial Risk

The famous Capital Asset Pricing Model (CAPM), widely used in practice, takes into account only the business risk associated with investments in a specific company [not the entire market (or industry)]. In practice, most listing companies use debt financing and operate at a non-zero leverage level. This means that the financial risk associated with the use of debt financing, along with business risk, must be taken into account. The purpose of this paper is to simultaneously account for business and financial risk. We combined the CAPM theory and the Modigliani-Miller (MM) theory, which is the perpetual limit of the BFO (Brusov-Filatova-Orekhova) theory. The article shows that R. Hamada’s attempt to take into account both business and financial risks has proved unsustainable, and the formulas he obtained, widely used in practice, are incorrect. The paper outlines the correct formulae that made it possible to generalize CAPM for the first time, taking into account both business and financial risk. The application of the new CAPM 2.0 model to a number of companies is considered and the difference between the results obtained within the framework of CAPM 2.0 and CAPM is demonstrated. CAPM is one of the main models [along with APT (arbitrage pricing theory) and WACC] within the income approach to business valuation. This significantly increases the value of the developed CAPM 2.0 approach, which can significantly improve the accuracy of the assessment.

Investigating the Relationship Between Environmental, Social, and Governance Factors and the Capital Asset Pricing Model

This study delves into the intricate relationship between the Capital Asset Pricing Model (CAPM) and Environmental, Social, and Governance (ESG) factors in the investment landscape. Through an extensive review of existing literature and comparative analyses, the paper uncovers the historical development of CAPM, the rise of ESG considerations, and their convergence in modern financial theory. The research aims to shed light on the ongoing debates surrounding integrating ESG factors into the CAPM framework, revealing both supportive and critical viewpoints. Through a critical evaluation of empirical studies, the paper identifies gaps in the current body of knowledge, emphasizing the need for further research to understand the interplay between ESG factors and CAPM. The study concludes that while ESG considerations have increasingly influenced investment decisions, their precise relationship with traditional financial models, such as CAPM, remains an area ripe for exploration.

Carbon dioxide and asset pricing: Evidence from international stock markets

We use carbon dioxide (CO2) emissions growth to measure consumption risk within a consumption-based capital asset pricing model framework. Given the comprehensive worldwide coverage of CO2 emissions, this measure allows us to use the full history of stock market data in the US, Europe, the world, and fifteen international markets. For the US (Europe/the world), we are able to explain the observed equity market premium with a relative risk aversion of 6 (10/12), which is less than half the size of that estimated using the canonical expenditures-based consumption growth measure. The average estimated relative risk aversion across fifteen other international markets is 5. We also find evidence that the growth of CO2 emissions is a priced risk factor that captures the cross section of stock portfolio returns.

Effectiveness of OLS and SVR in Return Prediction: Fama-French Three-factor Model and CAPM Framework

This study aims to apply the Support Vector Regression (SVR) algorithm under the Fama-French 3-factor model (FF3) theoretical framework to predict the return of a diversified portfolio. Data was collected on the Ho Chi Minh City Stock Exchange (HOSE) from 2010 to 2022 by month, with 145 observations. Firstly, the study compared the two theoretical models, the Capital Asset Pricing Model (CAPM) and FF3, and investigated that FF3 explains volatility in portfolio returns better than CAPM. Furthermore, to forecast the return rate, the study applied Ordinary Least Square (OLS) for CAPM and FF3 and SVR methods for CAPM and FF3. This research used the roll window method to train-test the model and Root Mean Square Error (RMSE) to evaluate the model’s accuracy. An F test was used to compare the performance of these four models. As a result, the FF3 model uses the SVR algorithm more efficiently than the OLS and CAPM.

A Measure of Pure Causality: Application to the CAPM Framework

An observed correlation between two variables, unless there are some special conditions, includes the possibility of multiple relations among the two and a third variable. The correlation coefficient is therefore not sufficient to measure the pure relation between two variables. I propose a measure of pure causality (pure predictability) and a linear regression model to estimate it. I apply this method to the capital asset pricing model (CAPM) framework, and analyze the pure predictability of asset returns.

Systematic Risk at the Industry Level: A Case Study of Australia

The cornerstone of the capital asset pricing model (CAPM) lies with its beta. The question of whether or not beta is dead has attracted great attention from academics and practitioners in the last 50 years or so, and the debate is still ongoing. Many empirical studies have been conducted to test the validity of beta within the framework of CAPM. However, it is a claim of this paper that beta at the industry level has been largely ignored in the current literature. This study is conducted to examine if beta, proxied for a systematic risk, should be considered valid in the application of the CAPM at the industry level for Australia using daily data on 2200 stocks listed on the Australian Securities Exchange from January 2007 to 31 December 2016. Various portfolio formations are utilized in this paper. General economic conditions such as interest rate, inflation, and GDP are examples of systematic risk. Findings from this study indicate that the selection of portfolio construction, estimation technique, and news about economic conditions significantly affects the view whether or not beta should be considered as a valid measure of systematic risk.

The Market Risk of Corporate Bonds

Although the capital asset pricing model (CAPM) was, at its origin, intended for all tradeable assets, it is rarely applied to bonds. Rather than appraising risk with respect to a market portfolio, bond portfolio managers rely on directly observable measures. The authors build a model for corporate bonds that stands close to this practice in that it converts ad hoc risk appraisals into a singular variance forecast. The model provides as such a pertinent definition of corporate bond market risk. The model sheds new light on an ongoing debate over which factors to focus on in a corporate-bond investment. Equity-style factors are being proposed, such as size, value, and momentum, which are tested in an off-key CAPM framework. The authors’ model gives insight into how these factors accord with the conventional risk measures. TOPICS:Fixed-income portfolio management, analysis of individual factors/risk premia, factor-based models Key Findings • Bond factor investing remains underdeveloped compared to equity factor investing, the reason being that the notion of bond factors is unclear—more precisely, it is not clear where market risk ends and factor risk starts. • We build a risk model that marks the divide between systematic market risk and style factor risk for corporate bonds. • We provide evidence that the bond style factors proposed to date are ambiguous. Their outperformance is largely due to active market bets, not style bets.

Aggregate Volatility Risk and Empirical Factors: An International Study

ABSTRACT We study the aggregate volatility risk in international stock markets. We examine four regional (North America, Europe, Japan, and Asia Pacific) stock markets to see if the aggregate volatility risk is priced and find out its relationship with regional empirical factors. We find that the aggregate volatility risk is priced robustly across stocks in all regions but Japan. Within the intertemporal capital asset pricing model framework, we show that the aggregate volatility risk is closely connected with the momentum profits. Our theoretical framework coupled with the return and volatility spillover effects hints at an interesting explanation for the coexistence of global and local factors.

Internal control quality, voluntary disclosure, and cost of equity capital: The case of an unregulated market

This paper examines the direct effect of internal control quality (ICQ) on cost of equity capital and whether ICQ has a moderating effect on the association between voluntary disclosure and cost of equity capital in an emerging market (Egypt). ICQ is measured using a survey of external auditors. A content analysis approach is used to proxy for the level of voluntary disclosure in annual reports. Finally, the Capital Asset Pricing Model framework is used to estimate cost of equity capital. Based on a sample of 512 firm‐year observations over the period 2007–2014, we find that ICQ is negatively and significantly associated with cost of equity capital, indicating that better controls reduce cost of equity capital as predicted by theory. In addition, ICQ moderates the association between voluntary disclosure and cost of equity capital since this association is only negative and significant for companies characterized by high ICQ. These findings remain stable after controlling for endogeneity concerns and political instability. Our study contributes to the internal control literature by focusing on an emergent unregulated market with respect to internal control disclosure and documents that ICQ plays an important role in reducing cost of equity capital (either directly or indirectly) by increasing the value relevance of voluntary disclosure among investors on the Egyptian stock exchange.

The role of liquidity in asset pricing: the special case of the Portuguese Stock Market

Purpose The aim of this paper is to examine the role of liquidity in asset pricing in a tiny market, such as the Portuguese. The unique setting of the Lisbon Stock Exchange with regards to changes in classification from an emerging to a developed stock market, allows an original answer to whether changes in the development of the market affect the role of liquidity in asset pricing. Design/methodology/approach The authors propose and compare two alternative implications of liquidity in asset pricing: as a desirable characteristic of stocks and as a source of systematic risk. In contrast to prior research for major stock markets, they use the proportion of zero returns which is an appropriated measure of liquidity in tiny markets and propose the separated effects of illiquidity in a capital asset pricing model framework over the whole sample period as well as in two sub-samples, depending on the change in classification of the Portuguese market, from an emerging to a developed one. Findings The overall results of the study show that individual illiquidity affects Portuguese stock returns. However, in contrast to previous evidence from other markets, they show that the most traded stocks (hence the most liquid stocks) exhibit larger returns. In addition, they show that the illiquidity effects on stock returns were higher and more significant in the period from January 1988 to November 1997, during which the Portuguese stock market was still an emerging market. Research limitations/implications These findings are relevant for investors when they make their investment decisions and for market regulators because they reflect the need of improving the competitiveness of the Portuguese stock market. Additionally, these findings are a challenge for academics because they exhibit the need for providing alternative theories for tiny markets such as the Portuguese one. Practical implications The results have important implications for individual and institutional investors who can take into account the peculiar effect of liquidity in stock returns to make proper investment decision. Originality/value The Portuguese market provides a natural experimental area to analyse the role of liquidity in asset pricing, because it is a tiny market and during the period studied it changed from an emerging to a developed stock market. Moreover, the authors have to highlight that previous evidence almost exclusively focuses on the US and major European stock markets, whereas studies for the Portuguese one are scarce. In this context, the study provides an alternative methodological approach with results that differ from those theoretically expected. Thus, these findings are a challenge for academics and open a theoretical and a practical debate.

Internal Control Quality, Disclosure and Cost of Equity Capital: The Case of an Unregulated Market

This paper examines the direct effect of internal control quality (ICQ) on cost of equity capital and whether ICQ has a moderating effect on the association between voluntary disclosure and cost of equity capital in an emerging market (Egypt). ICQ is measured using a survey of external auditors. A content analysis approach is used to proxy for the level of voluntary disclosure in annual reports. Finally, the Capital Asset Pricing Model framework is used to estimate cost of equity capital. Based on a sample of 512 firm‐year observations over the period 2007–2014, we find that ICQ is negatively and significantly associated with cost of equity capital, indicating that better controls reduce cost of equity capital as predicted by theory. In addition, ICQ moderates the association between voluntary disclosure and cost of equity capital since this association is only negative and significant for companies characterized by high ICQ. These findings remain stable after controlling for endogeneity concerns and political instability. Our study contributes to the internal control literature by focusing on an emergent unregulated market with respect to internal control disclosure and documents that ICQ plays an important role in reducing cost of equity capital (either directly or indirectly) by increasing the value relevance of voluntary disclosure among investors on the Egyptian stock exchange.

Short-Term Interest Rates and Stock Market Anomalies

We present a simple 2-factor model that helps explain several capital asset pricing model (CAPM) anomalies (value premium, return reversal, equity duration, asset growth, and inventory growth). The model is consistent with Merton’s intertemporal CAPM (ICAPM) framework, and the key risk factor is the innovation on a short-term interest rate, the federal funds rate, or the T-bill rate. This model explains a large fraction of the dispersion in the average returns of the joint market anomalies. Moreover, the model compares favorably with alternative multifactor models widely used in the literature. Hence, short-term interest rates seem to be relevant for explaining several dimensions of cross-sectional equity risk premia.

Disclosure, ownership structure, earnings announcement lag and cost of equity capital in emerging markets

Purpose – The purpose of this paper is to examine the effect of voluntary disclosure, ownership structure attributes and timely disclosure on cost of equity capital in the emerging Egyptian capital market. Design/methodology/approach – A content analysis of annual reports is used to measure the extent of voluntary disclosure. Earnings announcement lag (EAL) is used to measure the quality of voluntary disclosure (i.e. timely disclosure). Finally, the Capital Asset Pricing Model (CAPM) framework is used to estimate cost of equity capital. Findings – The authors find a negative relationship between the level of voluntary disclosure and cost of equity capital. More specifically, the authors document that this association is strongly significant under high ownership dispersion, low government ownership and shorter EAL. Finally, EAL is positively associated with cost of equity capital. Research limitations/implications – The authors use the CAPM framework as a proxy for the cost of equity since forecasted earnings per share are not communicated by financial analysts in the Egyptian Stock Exchange. Practical implications – The findings demonstrate for managers that the increased levels of voluntary and timely disclosure reduce the cost of external finance and improve the marketability of firms’ equities, which may directly impact growth opportunities especially when information is communicated to investors in a timely fashion. For regulators, it provides evidence that high government ownership reduces the value relevance of voluntary disclosure among investors, while free float as a proxy for high ownership dispersion improves it. Originality/value – The findings show that corporate disclosure policy depends more on the managers’ incentives to provide informative annual reports than on standards and regulations. The study also represents a first attempt that demonstrates how ownership structure and timely disclosure influence the relationship between disclosure and cost of equity capital.

A pricing kernel approach to valuing options on interest rate futures

This paper builds on existing asset pricing models in an intertemporal capital asset pricing model framework to investigate the pricing of options on interest rate futures. It addresses the issues of selecting the preferred pricing kernel model by employing the second Hansen–Jagannathan distance criterion. This criterion restricts the set of admissible models to those with a positive stochastic discount factor that ensures the model is arbitrage-free. The results indicate that the three-term polynomial pricing kernel with three non-wealth-related state variables, namely the real interest rate, maximum Sharpe ratio, and implied volatility, clearly dominates the other candidates. This pricing kernel is always strictly positive and everywhere monotonically decreasing in market returns in conformity with economic theory.

ANALYZING AND ESTIMATING PORTFOLIO PERFORMANCE OF BANGLADESH STOCK MARKET

Capital Asset Pricing Model (CAPM) is one of the most important developments in the finance literature. Simply, CAPM is a model that describes the relationship between risk and expected return. The theoretical validity of CAPM is well tested and accepted but the practical validity of CAPM is in questioned. This study is designed to analyze and estimate the portfolio performance of Bangladesh stock market in a CAPM framework. For this study, monthly stock returns from 80 companies for the period of January 2005 to December 2009 are chosen. In order to examine whether the CAPM is satisfied in the portfolio or not, the 80 stocks are arranged in descending order of beta and 10 portfolios are being made of eight stocks in each. The All Share Price Index (DSI) is used as a proxy for the market portfolio and Bangladesh government 3-Month T-bill rate is used as the proxy for the risk-free asset. The results of this analysis show that the intercept terms are not significantly different from zero, linearity in the securities market line and insignificant unique risk for the 10 portfolios during the period. But, the results in term of slope contradict the CAPM hypothesis and indicate evidence against the CAPM in the portfolios. This analysis will obviously be used as a basis of reference for future investigates and the researchers and they will get proper instruction from this study.

A Validity Test of Capital Asset Pricing Model for Dhaka Stock Exchange

Capital Asset Pricing Model (CAPM) was a revolution in financial theory. CAPM postulates an equilibrium linear association between expected return and risk of an asset.This study investigates a risk-return relationship within the CAPM framework in Dhaka Stock Exchange (DSE) using monthly stock returns from 80 non-financial companies for the period of January 2005 to December 2009.From the CAPM empirical analysis, it is observed that intercept term is significantly different from zero and insignificant but there exists a positive relationship between beta and share return.The results of the study refute the CAPM hypothesis and offer evidence against the CAPM in DSE market. However, there exists linearity in the securities market line. The unique risk and the interaction are insignificant during the period.

Explicit Discretization Programming Approach to Capital Asset Pricing Model

When estimating higher-order derivatives of a partial differential equation, it is often essential to compute approximations for artificial boundaries. In this paper we formulate an explicit discretization model for approximation of beta-coefficient of Capital Asset Pricing Model (CAPM). The method calculates higher-order derivatives for beta-coefficient function using discrete data points. Using Cartesian Laplacian Operator the paper estimates higher-order beta approximation for non-uniform multi-dimensional discretization. The method underlying partial differential equation is stated consistent with both uniform and non-uniform grid points as represented by the linearized scheme in both single and multi-dimensional discretization of systematic risk within the CAPM framework.

New Methodologies in the Valuation of Interest Rate Options

This paper values interest rate options using an improved parametric pricing kernel in the Merton (1973) intertemporal capital asset pricing model framework. In contrast to Liu, Kuo and Coakley (2007), the pricing kernel is driven by the following three state variables: the real interest rate, the Jensen's alpha, and the market volatility. Parameters in the pricing kernel are estimated using the Hansen (1982) two-step generalized method of moments. The results show that all three state variables are significant in the pricing kernel of LIBOR options. The Chebyshev polynomial pricing kernel dominates the iso-elastic power function pricing kernel. Finally, the five-term polynomial pricing kernel is superior to the fourth order polynomial which in turn is superior to the three-term expansion in the Hansen and Jagannathan (1997) distance measure comparison.

Are the China-related stock markets segmented with both world and regional stock markets?

Implementing the Capital Asset Pricing Model framework, this study investigates the integration of three China-related stock markets, namely, the A-, B- and H-share markets, with both the Hong Kong stock market and the world market. An analysis of market segmentation versus integration using the Jorion and Schwartz model suggests that the A-share market was a segmented market during the period 1995–2004. However, evidence of a higher-level integration between the A- and B-share markets, and the A-share and Hong Kong stock markets is found in the sub-period tests. The hypothesis that the B- and H-share markets are becoming increasingly integrated with the world stock market is not supported.