ANOTHER LOOK AT THE CAPM: THE INFLUENCE OF BULL AND BEAR MARKETS Ailie Charteris & Claire Ryley School of Account

1. ANOTHER LOOK AT THE CAPM: THE INFLUENCE OF BULL AND BEAR MARKETS AilieCharteris & Claire RyleySchool of Accounting, Economics and Finance

3. Size-Sorted Portfolios P/E-Sorted Portfolios Beta-Sorted Portfolios

4. Findings notunique to South Africa • Fama and French (1992) – flat SML • Howton and Peterson (1998) – negatively-sloped SML Beta is not an adequate measure of risk • Possible explanations? • CAPM doesn’t take into account all risk factors • Data discrepancies • CAPM doesn’t allow for variation in risk over time

5. CONDITIONAL CAPM • Pettengillet al. (1995):Realised vs. expected returns • Rm > Rf to compensate investors for the greater risk. • BUT, if Rm was always > Rf no investor would hold Rf. • Exists a non-zero probability that Rm < Rf. • Therefore: conditional relation between beta and returns • +ve when market risk premium is +ve • -ve when market risk premium is -ve

6. Results: • significantly positive and significantly negative • The conditional model has also performed well in other markets Average Portfolio Return: Positive and Negative Excess Market Return Periods Source:Pettengillet al. (1995: 111)

7. DUAL-BETA CAPM • Risk may vary under different market conditions • Dual-beta model (Bhardwaj & Brooks, 1993): beta for bull markets and a separate beta for bear markets • Results: • Time-series: bull and bear market betas significantly different • Cross-sectional: significantly positive and significantly negative

8. RESEARCH PROBLEM CAN THE CONDITIONAL CAPM OR THE DUAL-BETA CAPM EXPLAIN THE CROSS-SECTION OF SHARE RETURNS IN SOUTH AFRICA? “The findings of this study present an unambiguous empirical contradiction of the CAPM and a challenge for future theories to predict” (van Rensburg and Robertson, 2003a: 14). “This study provides unambiguous confirmation of the evidence presented by van Rensburg and Robertson (2003a) that the CAPM is unable to explain or describe the generation of returns on the JSE, and its contradiction creates a vacuum which begs to be filled” (Strugnellet al., 2011: 14).

9. METHOD • Test Period: Jan 2000-Dec 2009 • 20 industry-sorted portfolios (15 financial and industrial) • Fama and MacBeth (1973) two-pass approach • 1st pass: time-series regression to obtain beta values for each portfolio for each month using immediately preceding 60 months. • 2nd pass: cross-sectional regression across the portfolios for each month. Parameter estimates averaged across months in the sample. • Panel: adjust for fixed/ random period and cross-sectional effects BUT THERE IS AN ALTERNATIVE TO THE 2ND PASS …

10. RESULTS: CAPM

11. RESULTS: C-CAPM

12. Average Portfolio Return: Positive and Negative Excess Market Return Periods

13. RESULTS: DB-CAPM 14 of 20 portfolios: βdown > βup. Difference: T-Stat = 3.5335***

14. RESULTS: DB-CAPM • Exceptions: resource portfolios where βdown < βup. Resource shares are thus affected less by market downturns than upturns than financial and industrial shares. • Beta values are small on average. WHY? Difference: T-Stat = 7.2926***

15. RESULTS: DB-CAPM

16. CONCLUSION • Conditional CAPM – some improvement on the CAPM once market segmentation taken into account. • Dual-beta model – BIG improvement once market segmentation taken into account. • Further Research: • Can the dual-beta CAPM explain the returns of size and P/E sorted portfolios? • Continuously changing time-varying parameter to measure the dual-betas as per Woodward and Anderson (2009).