Empirical testing of the CAPM on the JSE

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Empirical testing of the CAPM on the JSE. Mike Ward, Chris Muller Gordon Institute of Business Science University of Pretoria NERSA Conference August 2012. An economic return on the RAB?. Regulatory Asset Base. Shareholder Capital. The cost of equity “The CAPM” Re = Rf + β .MRP. - PowerPoint PPT Presentation

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The CAPM is CRAP

Empirical testing of the CAPM on the JSEMike Ward, Chris MullerGordon Institute of Business ScienceUniversity of PretoriaNERSA ConferenceAugust 2012

1Mike Ward 2011The CAPM is CRAP - James MontierAn economic return on the RAB?Regulatory Asset BaseShareholder CapitalDebt CapitalThe cost of equityThe CAPMRe = Rf + .MRPThe cost of debtThe Capital Asset Pricing ModelBeta = 1.0ReturnRf = 7%MarketRiskPremium = 5%High beta shares are more risky, so give better returns0.8Rf = 11%Risk (beta)3Mike Ward 2011The CAPM is CRAP - James Montier

Betting Against Beta, Andrea Frazzini and Lasse H. Pedersen, Oct 2011 Prior ResearchData: All US Shares 1928 - 2009

Betting Against Beta, Andrea Frazzini and Lasse H. Pedersen, Oct 2011 Data: 18 International Markets 1984 - 2009Fama and French (2004) estimated betas for every share on the NYSE, AMEX and NASDAQ from 1923 2003 using 2-5 years prior data and compared with their return over the next 12 months:

6Mike Ward 2011The CAPM is CRAP - James MontierThe largest 600 US shares over the period 1963 2006 placed into 10 portfolios ito beta.

7Mike Ward 2011The CAPM is CRAP - James MontierPrior research on the JSEStrugnell, Gilbert & Kruger (2011) IAJBeta has no predictive power for returns on the JSEData from 1994 2007Included too many small shares

van Rensburg & Robertson (2003) IAJIf anything, beta is inversely related to returns!Data from 1990 2000Included too many small shares8Rational for researchThe CAPM is a pillar of financial theory:taught on all finance coursesfound in all finance text booksused regularly in the financial services industryMarkowitz, Miller & Sharpe shared a Nobel prizeWe have 25 years of JSE data1985 to 2011We can improve on the methodologyMethodologySelect the largest 160 companies in Dec 1984Estimate betas using prior years return dataOLS beta60 monthly data pointsDimsonMultiple regression (+1,0,-1,-2,-3,-4)Rank betasConstruct 5 equal weighted portfolios of 32 sharesMeasure portfolio return over the next 3 monthsRepeat for next quarter

10

99% of JSEs market capitalisation

Presentation of findingsWe track the daily value of each portfolio (quintile)We re-balance each portfolio quarterlyWe retain the value of the portfolioEqually weightWe ignore transaction costsWe graph the resultsWe benchmark against the ALSI total return indexWe plot a price relative versus the J203ResultsOLS Betas - monthlyOLS Betas - weeklyDimson Betas - monthlyDimson Betas - weeklyVolatility - Daily

Summary of ResultsAnnualised returns for equal weighted portfolio quintiles over the period 31Dec1986 - 31Dec2011Risk MeasureNumber of ObsALSI Index R203Highest Beta QuintileQuintile 2Quintile 3Quintile 4Lowest Beta QuintileOLS Monthly Beta6015.7%7.7%12.1%18.1%21.6%20.4%OLS Weekly Beta10415.7%4.6%15.4%20.4%19.9%19.3%Dimson Monthly Beta6015.7%7.9%16.3%19.3%19.0%17.4%Dimson Weekly Beta10415.7%5.7%15.3%19.0%19.5%20.8%Volatility Daily6015.7%9.7%13.5%17.7%20.8%18.2%Average annualised Return15.7%7.1%14.5%18.9%20.2%19.2%Conclusion:

High risk (beta) = Low returnBen Graham once argued that: "Beta is a more or less useful measure of past price fluctuations of common stocks. What bothers me is that authorities now equate the beta idea with the concept of risk. QuestionsFor those interested:The full paper will be published in the forthcoming: Investment Analyst Journalhttp://www.iassa.co.za/journals/