EmpiricalTestsoftheCapitalAssetPricingModel(Chapter9).ppt

Empirical Tests of theCapital Asset Pricing Model(Chapter 9) Traditional Tests of the CAPM Black, Jensen, and Scholes Study Fama and MacBeth Study Roll’s Critique of Tests of the CAPM Additional Evidence Traditional Tests of the CAPM The CAPM predicts that all investors hold portfolios that are efficient in expected return, standard deviation space. Therefore, the Market Portfolio is efficient. To test the CAPM, we must test the prediction that the Market Portfolio is positioned on the efficient set. Initial testing of the CAPM did not test directly the prediction, “The Market Portfolio is efficient.” Instead, researchers followed the theme, “If a linear positive relationship exists between portfolio return and beta, the Market Portfolio must be efficient.” Traditional Tests of the CAPM (Continued) Two classical traditional studies: Black, F., Jensen, M. C., Scholes, M. “The Capital Asset Pricing Model: Some Empirical Tests,” in Ed. Jensen, M. C. Studies in Theory of Capital Markets. New York: Praeger, 1972. Fama, E. F., MacBeth, J., “Tests of Multiperiod Two Parameter Model,” Journal of Political Economy (May 1974). Black, Jensen, and Scholes Study Sample: All stocks on the NYSE (1926 - 1965). Market Index: Equally weighted portfolio of all stocks on the NYSE. Outline of the Study 1. Estimate a beta for each stock using monthly returns during the period, 1926 - 1930, (i.e., 60 months): 4. Repeat Steps 1 through 3 many times: 5. Results of the above process - A series of monthly returns for 10 portfolios: Portfolio 1/31 2/31 3/31 . . . . 12/65 1 Thirty five years of monthly returns 2 (i.e., 35x12 = 420 monthly returns for . each of the 10 portfolios) 10 6. For the entire 35 year period, calculate the mean monthly return, and estimate the beta coefficient  for each of the 10 portfolios: 7. Regress the mean portfolio returns against the portfolio betas (i.e., estimate the expost Security Market Line). See the f