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Empirical testing of the CAPM on the JSE

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.

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Empirical testing of the CAPM on the JSE

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  1. Empirical testing of the CAPM on the JSE Mike Ward, Chris Muller Gordon Institute of Business Science University of Pretoria NERSA Conference August 2012

  2. An economic return on the RAB? Regulatory Asset Base Shareholder Capital The cost of equity “The CAPM” Re = Rf + β.MRP Debt Capital The cost of debt

  3. The Capital Asset Pricing Model High beta shares are more risky, so give better returns Return Rf = 11% MarketRiskPremium= 5% Rf = 7% 0.8 Beta = 1.0 Risk (beta)

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

  5. Data: 18 International Markets 1984 - 2009 Betting Against Beta, Andrea Frazzini and Lasse H. Pedersen, Oct 2011

  6. Fama 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:

  7. Prior research on the JSE • Strugnell, Gilbert & Kruger (2011) IAJ • “Beta has no predictive power for returns on the JSE” • Data from 1994 – 2007 • Included too many small shares • van Rensburg & Robertson (2003) IAJ • “If anything, beta is inversely related to returns!” • Data from 1990 – 2000 • Included too many small shares

  8. Rational for research • The CAPM is a pillar of financial theory: • taught on all finance courses • found in all finance text books • used regularly in the financial services industry • Markowitz, Miller & Sharpe shared a Nobel prize • We have 25 years of JSE data • 1985 to 2011 • We can improve on the methodology

  9. Methodology • Select the largest 160 companies in Dec 1984 • Estimate betas using prior years return data • OLS beta • 60 monthly data points • Dimson • Multiple regression (+1,0,-1,-2,-3,-4) • Rank betas • Construct 5 equal weighted portfolios of 32 shares • Measure portfolio return over the next 3 months • Repeat for next quarter

  10. 99% of JSE’s market capitalisation

  11. Presentation of findings • We track the daily value of each portfolio (quintile) • We re-balance each portfolio quarterly • We retain the value of the portfolio • Equally weight • We ignore transaction costs • We graph the results • We benchmark against the ALSI total return index • We plot a price relative versus the J203

  12. Results

  13. OLS Betas - monthly

  14. OLS Betas - weekly

  15. Dimson Betas - monthly

  16. Dimson Betas - weekly

  17. Volatility - Daily

  18. Summary of Results

  19. Conclusion:High risk (beta) = Low return Ben 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.

  20. Questions… • For those interested: • The full paper will be published in the forthcoming: • Investment Analyst Journal • http://www.iassa.co.za/journals/

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