Validity of Capital Assets Pricing Model: Evidence from KSE-Pakistan

Abstract

Capital Assets Pricing Model (CAPM) is the widely tested, accepted and rejected model of asset pricing. From its beginning (1964) it has occupied the prime place and still part of the text books on finance in leading business schools. This study is conducted in Pakistani institutional frame work covering six years period (2003 t0 2008). Purpose of the research is to form an opinion about authenticity and validity of CAPM. Our methodology includes the beta calculation through variance/covariance approach in order to predict the required return, consequently price the underlying security. Pricing of the security and risk calculation is required by the investors in portfolio composition. In this study returns used are the capital gains only due to unavailability of information about the dividends paid. Historical returns are used for calculation of results. Findings suggest that CAPM gives accurate results for a limited period and for few companies only. Out of 360 observations only 28 results supporting CAPM while 332 are against it, hence model is rejected in this institutional frame work.

Keywords: Beta, Risk, Return, Asset Pricing, Pakistan

JEL Classification: G11, G12, G32