Volume 9, Issue 2, November 2014, Pages 600–614
Anthony K. Muthama1, Macharia George Munene2, and Ondabu Ibrahim Tirimba3
1 Department of Finance, Accounting and Economics, Jomo Kenyatta University of Agriculture and Technology, PHD Finance Candidate, Nairobi, Kenya
2 Department of Finance, Accounting and Economics, Jomo Kenyatta University of Agriculture and Technology, PHD Finance Candidate, Nairobi, Kenya
3 Department of Finance, Accounting and Economics, Jomo Kenyatta University of Agriculture and Technology, PHD Finance Candidate, Nairobi, Kenya
Original language: English
Copyright © 2014 ISSR Journals. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.
This paper reviews an advanced literature on capital asset pricing model. It starts by a brief introduction in welcoming scholars into the model background and its relevant assumptions and implications. It then explains the model in its real form, both the conceptual and the analytical part of it. The CAPM and the Index Model is then clearly looked at and explained in the dimensions of the Index Model and Realized Returns and also the Index Model and the Expected Return-Beta Relationship. The researchers penultimately look at a number of empirical tests for CAPM to explain the validity of the model. Some of the Empirical tests looked at by this paper are the tests by Lintner, which is reproduced in Douglas (1968), Fama and MacBeth (1973), tests by Black, Jensen and Scholes (1972), tests by Stambaugh (1982), tests by Gibbons (1982), Miller and Scholes (1972) tests and the Roll (1977) Critique. The paper finds that, there is strong empirical evidence invalidating the CAPM and on the other hand it is clear that the empirical findings themselves are not sufficient to discard the CAPM. The paper found out further that CAPM cannot be used for estimating the cost of capital, to evaluate the performance of fund managers or as an aid in event-study analysis. For practical purposes, Merton's (1973) intertemporal CAPM or some form of the APT would have to be resorted to for the purpose of explaining expected stock returns.
Author Keywords: Mean Return, testable, beta, CAPM, Expected stock returns.
Anthony K. Muthama1, Macharia George Munene2, and Ondabu Ibrahim Tirimba3
1 Department of Finance, Accounting and Economics, Jomo Kenyatta University of Agriculture and Technology, PHD Finance Candidate, Nairobi, Kenya
2 Department of Finance, Accounting and Economics, Jomo Kenyatta University of Agriculture and Technology, PHD Finance Candidate, Nairobi, Kenya
3 Department of Finance, Accounting and Economics, Jomo Kenyatta University of Agriculture and Technology, PHD Finance Candidate, Nairobi, Kenya
Original language: English
Copyright © 2014 ISSR Journals. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.
Abstract
This paper reviews an advanced literature on capital asset pricing model. It starts by a brief introduction in welcoming scholars into the model background and its relevant assumptions and implications. It then explains the model in its real form, both the conceptual and the analytical part of it. The CAPM and the Index Model is then clearly looked at and explained in the dimensions of the Index Model and Realized Returns and also the Index Model and the Expected Return-Beta Relationship. The researchers penultimately look at a number of empirical tests for CAPM to explain the validity of the model. Some of the Empirical tests looked at by this paper are the tests by Lintner, which is reproduced in Douglas (1968), Fama and MacBeth (1973), tests by Black, Jensen and Scholes (1972), tests by Stambaugh (1982), tests by Gibbons (1982), Miller and Scholes (1972) tests and the Roll (1977) Critique. The paper finds that, there is strong empirical evidence invalidating the CAPM and on the other hand it is clear that the empirical findings themselves are not sufficient to discard the CAPM. The paper found out further that CAPM cannot be used for estimating the cost of capital, to evaluate the performance of fund managers or as an aid in event-study analysis. For practical purposes, Merton's (1973) intertemporal CAPM or some form of the APT would have to be resorted to for the purpose of explaining expected stock returns.
Author Keywords: Mean Return, testable, beta, CAPM, Expected stock returns.
How to Cite this Article
Anthony K. Muthama, Macharia George Munene, and Ondabu Ibrahim Tirimba, “Empirical Tests of Capital Asset Pricing Model and its Testability for Validity Verses Invalidity,” International Journal of Innovation and Applied Studies, vol. 9, no. 2, pp. 600–614, November 2014.
