Security Market Line Research Articles

Asymmetry, earnings announcements, and the beta-return relation

We find that the beta–return relationship is asymmetric around earnings announcements. The security market line has a positive slope in the days leading up to earnings announcements, but a negative slope in the days that follow. This striking shift in the risk–return trade-off is driven primarily by high-beta stocks. Moreover, a modified conditional market-timing beta strategy, incorporating the timing of earnings announcements, enhances profitability. Overall, the results lend empirical support to the theoretical predictions of Hong and Sraer (2016), which posit that beta amplifies disagreements regarding the stock market's prospects.

Corporate financing policies, financial leverage, and stock returns

We examine the interaction between equity returns and firms’ financing policies in a stochastic Ramsey model with heterogeneous firms. Motivated by empirical evidence, firms maintain stationary financial leverage ratios by issuing debt. We present a novel closed-form solution to this class of models and, subsequently, use this solution to show that restricting firms’ financing policies can explain various stylized facts of both the dynamic as well as the cross-sectional behavior of equity returns. Our restrictions induce persistent and countercyclical heteroskedasticity in returns, predictability by dividend–price ratios, a security market line that is “too flat”, and mean-reverting CAPM betas that correlate with leverage. Our model explains both established as well as recent empirical evidence, but challenges recent theoretical macro-finance explanations of the link between capital structure and equity returns.

Investment Decisions On Indonesia Energy Sector Companies By Capital Asset Pricing Model Model

This research was conducted to analyze the level of investment feasibility in IDX index stocks for the 2022 period using the Capital Asset Pricing Model (CAPM) method in determining investment decisions. This type of quantitative research is descriptive. The population of this study is Oil & Gas Storage, Distribution companies listed on the IDX-IC index for the period January - December 2022. The samples are 8 company shares that meet the criteria set by the researcher. This study uses SPSS linear regression analysis to determine the beta coefficient of the Capital Asset Pricing Modeling (CAPM) method and compares the expected return with the stock market rate of return during the observation period to further distinguish between efficient and inefficient stocks. The results of the observations show that 7 companies have efficient shares and 1 company that has inefficient shares which can be seen in the SML Security Market Line (SML) graph or the securities market line (GPS) of the CAPM model for efficient shares and inefficient shares.

Testing The Robustness of Capital Asset Pricing Model During the Covid-19 Crisis: Evidence from Indian Stock Market

In order to help investors better understand how risk and return work in the stock market when significant societal catastrophes strike, the COVID-19 pandemic is used as an instance to examine the Capital Asset Pricing Model's (CAPM) reliability in the Indian stock market during COVID-19 pandemic outbreak. This study's goal is to estimate the security market line CAPM test for Nifty Fifty stocks over the COVID-19 Period (2019–2021). two types of regression: first-pass and second-pass were used to assess the CAPM model in this study. Furthermore, using regression analysis, we calculate the excess return, beta, alpha, and R-Squared on the Nifty50 companies in first-pass regression. If the CAPM is true, then in second pass regression, Y0 should equal zero and Y1 should equal excess return. The t-test for beta is also not significant. As a result, the SML test was unsuccessful, and the CAPM does not accurately reflect the link between excess return and beta in the study. We cannot explain the relationship between return and stock sensitivity because the CAPM is invalid and the model does not adequately explain the outcome.

The Time Secret of Chinese A-Share Systematic Risk: Overnight and Intraday

ABSTRACT Based on all daily A-share data from January 2006 to December 2021, this study examines the relationship between overnight and intraday returns and market beta using Fama-Macbeth regressions and panel regressions to explore the reasons for the weak correlation between systematic risk and full-day returns in the Chinese A-share market. The results show that the overnight risk premium of the Chinese A-share market is significantly negative. The intraday risk premium is negligible when portfolios are sorted by beta, industry and Book-to-Market ratios, and stock characteristics. The slope of the securities market line (SML) tends to zero due to the interaction of the uncertain intraday risk premium and the negative correlation between overnight returns and market risk.

The Lost Capital Asset Pricing Model

Abstract We provide a novel explanation for the empirical failure of the capital asset pricing model (CAPM) despite its widespread practical use. In a rational-expectations economy in which information is dispersed, variation in expected returns over time and across investors creates an informational gap between investors and the empiricist. The CAPM holds for investors, but the securities market line appears flat to the empiricist. Variation in expected returns across investors accounts for the larger part of this distortion, which is empirically substantial; it offers a new interpretation of why “betting against beta” (BAB) works: BAB really bets on true beta. The empiricist retrieves a stronger CAPM on days when public information reduces disagreement among investors.

Beta and Coskewness Pricing: Perspective from Probability Weighting

Does Subjective Evaluation of Probability Impact Asset Prices? The Nobel Prize–winning capital asset pricing model (CAPM) predicts that expected excess return of any asset is positively proportional to its exposure to the overall market: the beta, leading to an upward-sloping security market line. However, this prediction is contradicted by empirical studies that the return–beta slope is often flat or even downward-sloping, a puzzle called the “beta anomaly.” The CAPM is premised upon the notion that market participants are all rational, including that they are able to objectively evaluate probabilities. However, evidence abounds that individuals are often unable to do so, examples being purchase of lottery tickets and insurance products, in which the extremely small probabilities of winning or losing big are exaggerated. This phenomenon of distorting probabilities at both tails is called “probability weighting” (PW), which is a key component of modern behavioral finance. The paper “Beta and Coskewness Pricing: Perspective from Probability Weighting” approaches the beta anomaly through PW. It offers an explanation of the beta anomaly via a new theoretical CAPM involving PW and an extensive empirical study.

TESTING THE APPLICABILITY OF THE CAPM MODEL USING SELECTED SHARES LISTED ON THE BELGRADE STOCK EXCHANGE

One of the basic types of portfolio valuation as well as valuation of individual company shares is the CAPM (Capital Asset Pricing) model, which uses a well-known measure of systemic risk in its analysis, which is beta. The CAPM model in its analysis uses the link between the systemic risk measure (beta) and the expected market return. Guided by this model, the analysis of monthly returns of selected shares on the Belgrade Stock Exchange in the period from 2011 to 2021 was performed in this research. In the research, the beta coefficient of selected shares was calculated with the help of the covariance of market return and stock return. The results and their statistical value were confirmed by the linear regression test. The rest of the research tests the applicability of the CAPM model to selected actions and in the same way, the SML (security market line) is devised, which is a graphical representation of the model. The research indicated that the basic assumptions of the CAPM model are not applicable as a predictor of future expected returns of selected shares on the Belgrade Stock Exchange due to various other elements that affect price movements and returns of selected shares not covered by the model.

Differential taxation and security market lines–a clarification

The literature on differential taxation of asset specific payoffs presents different representations of security market lines (SMLs), with puzzling features such as parallel lines and lines with the same intercept but different slopes - a security market fan. We show that these results can be traced back to using different combinations of pre-tax and after-tax figures for betas and expected returns. Above all, for betas based on returns and a stochastic discount factor (SDF), there is a single SML in after-tax expected return and after-tax beta space. Using pre-tax values for betas and/or expected returns leads to different representations in the respective beta and expected return space. With betas that use the market return instead of the SDF, it is important to distinguish whether tax payments are redistributed back to the agents. If they are, a single SML can only be obtained through a beta using the pre-tax market return and the after-tax return of single assets. In addition to SML representations, we also discuss differential taxation with respect to mean-variance frontiers in expected return and standard deviation spaces.

Asset market equilibrium under rational inattention

We propose a noisy rational expectations equilibrium model of asset markets with rationally inattentive investors. We incorporate any finite number of assets with arbitrary correlation. We also do not restrict the signal form and show that investors optimally choose a single signal, which is a noisy linear combination of all risky assets. This generates comovement of asset prices and contagion of shocks, even when asset payoffs are negatively correlated. The model also provides testable predictions of the impact of risk aversion, aggregate risk, and information capacity on the security market line, the portfolio dispersion, and the abnormal return.

Sentiment‐scaled CAPM and market mispricing

AbstractThis study explores the conditional version of the capital asset pricing model on sentiment to provide a behavioural intuition behind the value premium and market mispricing. We find betas (β) and the market risk premium to vary over time across different sentiment indices and portfolios. More importantly, the state β derived from this sentiment‐scaled model provides a behavioural explanation of the value premium and a set of anomalies driven by mispricing. Different from the static β–return relation that gives a flat security market line, we document upward security market lines when plotting portfolio returns against their state βs and portfolios with higher state βs earn higher returns.

The Invisible Portfolio

A portfolio sorted on the intercepts of a multi-factor model - the invisible portfolio - is the optimal portfolio for improving the model's mean-variance efficiency. This portfolio, similar to the betting-against-beta (BAB) factor, benefits from the distortions in the security market (or factor) lines. Whereas the BAB factor adjusts for the flatness in any one factor's security factor line, the invisible portfolio optimally adjusts for all such distortions. The invisible portfolio increases the five-factor model's out-of-sample maximum squared Sharpe ratio from 0.98 to 1.38. The invisible portfolio is an intuitive and theoretically founded method for improving all factor models.

Portofolio Optimization Through MPT on any Economic Situation on Indonesian Stock Exchange (2010-2020)

Modern portfolio theory told us that investors are tend to optimize the expected return of investment subject to a target of risk perception. In the real world, risks are depend on may factors, such as systematic risk (market risk and macroeconomics risk which can not be controlled to diversification) and non-systematic risk (specific company risk which can not be controlled through diversification). Applying Security Market Line Approach, constrained maximization and considering changes in economic situation between 2010-2020, we found that Modern Portfolio Theory can improve portfolio performance when limited impact is spotted on minimizing systematic risk of portfolio.

Heterogeneous Beliefs and the Beta Anomaly in the Chinese A-share Stock Market

ABSTRACT The beta anomaly indicates that high-beta stocks earn low future returns. We confirm the existence of the beta anomaly in the Chinese A-share stock market and propose that heterogeneous beliefs and arbitrage limits play important roles in explaining the beta anomaly. We provide a new proxy for aggregate disagreement based on analysts’ earnings forecasts and find that the beta anomaly does not exist in stocks with low arbitrage limits and periods with low aggregate disagreement. Furthermore, a higher aggregate disagreement period leads to a more concave Security Market Line.

How the pandemic taught us to turn smart beta into real alpha

The ongoing COVID-19 pandemic has strongly reminded equity investors that rare but extreme events occur from time to time. At the individual firm level, such events also impact the likelihood of bankruptcy, a feature that is not well represented in the traditional Capital Asset Pricing Model. This paper presents a functional form for equity asset pricing that is realistic, and reconciles the observed high equity risk premium with the observed lower than expected slope of the Security Market Line. Most importantly, we will demonstrate how including the potential for such large events changes traditional views of equity returns and the known factors that contribute to those returns. On the basis of empirical examination of a dataset stretching over 30 years without survivorship bias, we conclude that when the probabilities of rare extreme events are considered, strategies that focus on “alpha” (risk adjusted return) as defined in Jensen (J Finance 23(2):389–416, 1967) are structurally superior to “smart beta” strategies that seek to outperform a market index benchmark.

The Risk-Free Asset Implied by the Market: Medium-Term Bonds instead of Short-Term Bills

In empirical tests of the capital asset pricing model, the theoretical risk-free asset is typically assumed to be 1-month Treasury bills. This article examines the implications of a misspecified risk-free asset—that is, the possibility that the true risk-free asset is a longer-maturity Treasury bond. A simple theoretical derivation leads to the testable prediction that low-beta (high-beta) stocks should then exhibit positive (negative) bond betas. The author finds strong empirical confirmation for these predictions. The market-implied risk-free asset can be pinpointed at medium-term (5-year) bonds. Concrete implications of this finding are a lower equity risk premium and a less steep security market line. TOPICS:Portfolio theory, portfolio construction, derivatives Key Findings • In empirical tests of the capital asset pricing model, the theoretical risk-free asset is typically assumed to be 1-month Treasury bills. This article examines the implications of a misspecified risk-free asset—that is, the possibility that the true risk-free asset is a longer-maturity Treasury bond. • A simple theoretical derivation leads to the testable prediction that low-beta (high-beta) stocks should then exhibit positive (negative) bond betas. • The author finds strong empirical confirmation for these predictions and can pinpoint the market-implied risk-free asset at medium-term (5-year) bonds. Concrete implications of this finding are a lower equity risk premium and a less steep security market line.

Governance by Constraint: The Corporate Governance Implications of an Anomaly

We study the corporate governance implications of the anomaly, generated by the fact that major equity investors overweight their portfolios toward high-beta stocks because of leverage constraints. We hypothesize that the resulting higher portfolio concentration will increase the monitoring incentives of investors and reduce the agency costs of the firms they own. We test this hypothesis by quantifying a measure of leverage constraint of mutual funds and relating it to their monitoring behavior and the portfolio firms' governance quality. We find that leverage-constrained funds monitor more actively – vote more often against management in contentious proposals and are more likely to induce CEO turnovers. Consequently, the portfolio firms have a higher value of cash holdings, lower need to alleviate agency problems through payouts, and higher investment efficiency. These effects are more pronounced as the beta anomaly becomes more acute, i.e., when the security market line gets flattened. We identify a causal effect using extreme fund outflows and the number of nearby banks as instruments for fund leverage constraints.

Growth Expectations out of WACC

We reconcile the empirically flat relation between historical betas and stock returns (flat security market line) with the common usage of the CAPM based on historical betas in valuation. Analysts bias cash flow growth expectations upwards for high-beta firms, so that the value-reducing effect of higher historical systematic risk cancels out and buy/sell-recommendations remain unrelated to beta. The association between beta and growth overestimation is driven by estimates conventionally used in the industry (e.g., Bloomberg betas), suggesting that analysts adjust growth expectations to offset beta's valuation effects, instead of exhibiting a coincidentally higher overoptimism for higher-beta firms.

Investor overconfidence and the security market line: New evidence from China

This paper documents a highly downward-sloping security market line (SML) in China, which is more puzzling than the typical “flattened” SML in the US, and does not reconcile with existing theories of the low-beta anomaly. We show that investor overconfidence offers some promises in resolving the puzzle in China: In the time-series dimension, the slope of the SML becomes more “inverted” when investors get more overconfident. This dynamic overconfidence effect is intensified with biased self-attribution. As a general symptom of overconfidence in the cross section, high-beta stocks are also the mostly heavily traded. After accounting for trading volume, there is no longer the low-beta anomaly at both the firm and portfolio levels. Mutual fund evidence reinforces the view that institutional investors actively exploit the portfolio implications of a downward-sloping SML by shying away from high-beta stocks and betting on low-beta stocks for superior performance.

THE IMPORTANCE OF INVESTMENT DECISIONS USING CAPITAL ASSET PRICING MODEL (CAPM) IN STOCK SECTOR TELECOMMUNICATION

The purpose of this study is to analyze the overall performance of company shares in the telecommunications sector based on stock returns and risks, and determine the grouping and valuation of shares that are efficient and inefficient based on the Capital Asset Pricing Model (CAPM) method for companies in the telecommunications sector that listed on the Indonesia Stock Exchange (IDX) for the period 2015-2018. From the 4 shares of the research sample company, there were 3 shares that were considered efficient (undervalued). An undervalued stock is a stock that has an individual Return (Ri) greater than the expected rate of return [E (Ri)] and is above the Security Market Line (SML).