CRORR_2_12.pdf - Croatian Operational Research Review(CRORR...

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Croatian Operational Research Review (CRORR), Vol. 2, 2011 102 RESEARCH OF BETA AS ADEQUATE RISK MEASURE-IS BETA STILL ALIVE? Ante Perkovi ć Faculty of Economics Split Matice hrvatske 31, 21000 Split Phone: ++ 38521318120; E-mail: [email protected] Abstract The capital asset pricing model (CAPM) is one of the most important models in financial economics and it has a long history of theoretical and empirical investigations. The main underlying concept of the CAPM model is that assets with a high risk (high beta) should earn a higher return than assets with a low risk (low beta) and vice versa. The implication which can be drawn out of this is that all assets with a beta above zero bear some risk and therefore their expected return is above the return of the risk-free rate. In this research observation on monthly stock prices on Croatian stock market from January 1 st 2005 until December 31 st 2009 is used to form our sample. CROBEX index is used as proxy of the market portfolio. The results demonstrate that beta can not be trusted in making investment decisions and rejects the validity of the whole CAPM model on Croatian stock market. Key words: CAPM, beta coefficients, Markowitz model, Zagreb Stock Exchange. 1. INTRUDUCTION The capital asset pricing model (CAPM) of William Sharpe (1964) and John Lintner (1965) marks the birth of asset pricing theory (resulting in a Nobel Prize for Sharpe in 1990). Since its introduction in early 1960s, CAPM has been one of the most challenging topics in financial economics. Almost any manager who wants to undertake a project must justify his decision partly based on CAPM. The attraction of the CAPM is that it offers powerful and intuitively pleasing predictions about how to measure risk and the relation between expected return and risk. Unfortunately, the empirical record of the model is poor—poor enough to invalidate the way it is used in applications. The CAPM’s empirical problems may reflect theoretical failings, the result of many simplifying assumptions. But, they may also be caused by difficulties in implementing valid tests of the model. The major focus of the tests has been to check whether returns are statistically related to betas. Recent evidence by Fama and French (1992,1996), Jegadeesh (1992) and others has shown that betas are not statistically related to returns, which has made these authors conclude that beta is totally unsuitable for describing the cross sectional difference in returns and that it is an inappropriate measure of risk. This paper is orientated on testing whether beta is a suitable measure of risk on Croatian stock market, by regressing beta of each stock and expected return of each stock. The results confirm the hypothesis that beta is not appropriate measure of risk on underdeveloped stock markets as Croatian.
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Croatian Operational Research Review (CRORR), Vol. 2, 2011 103 2. THE CAPITAL ASSET PRICING MODEL 2.1. The model This study will focus on the Sharpe-Lintner version of the CAPM, which is based on one period mean- variance portfolio theory of Markowitz. The Markowitz Model assumes that investors are risk averse and
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