Empirical testing of the CAPM on the JSE
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Empirical testing of the CAPM on the JSE
Mike Ward, Chris MullerGordon Institute of Business Science
University of PretoriaNERSA Conference
August 2012
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An economic return on the RAB?
Regulatory Asset Base
Shareholder Capital
Debt Capital
The cost of equity“The CAPM”
Re = Rf + β.MRP
The cost of debt
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The Capital Asset Pricing Model
Beta = 1.0
Retu
rn
Rf = 7%
MarketRiskPremium = 5%
High beta shares are
more risky, so give better
returns
0.8
Rf = 11%
Risk (beta)
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Betting Against Beta, Andrea Frazzini and Lasse H. Pedersen, Oct 2011
Prior ResearchData: All US Shares 1928 - 2009
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Betting Against Beta, Andrea Frazzini and Lasse H. Pedersen, Oct 2011
Data: 18 International Markets 1984 - 2009
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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:
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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
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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
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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
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99% of JSE’s market capitalisation
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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
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Results
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OLS Betas - monthly
Dec-84
Dec-85
Dec-86
Dec-87
Dec-88
Dec-89
Dec-90
Dec-91
Dec-92
Dec-93
Dec-94
Dec-95
Dec-96
Dec-97
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
0.016
0.156
1.563
15.625
156.250
7.7%
12.1%
18.1%
21.6%20.4%
-10.5%
15.8%
-6.9%
BetaOLS60m1BetaOLS60m2BetaOLS60m3BetaOLS60m4BetaOLS60m5RelativeJ203TRelative to J203T
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OLS Betas - weekly
Dec-84
Dec-85
Dec-86
Dec-87
Dec-88
Dec-89
Dec-90
Dec-91
Dec-92
Dec-93
Dec-94
Dec-95
Dec-96
Dec-97
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
0.016
0.156
1.563
15.625
156.250
4.6%
15.4%
20.4%19.9%19.3%
-12.3%
15.8%
-9.6%
BetaOLS104w1BetaOLS104w2BetaOLS104w3BetaOLS104w4BetaOLS104w5RelativeJ203TRelative to J203T
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Dimson Betas - monthly
Dec-84
Dec-85
Dec-86
Dec-87
Dec-88
Dec-89
Dec-90
Dec-91
Dec-92
Dec-93
Dec-94
Dec-95
Dec-96
Dec-97
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
0.016
0.156
1.563
15.625
156.250
7.9%
16.3%
19.3%19.0%17.4%
-8.1%
15.8%
-6.8%
BetaDimson60m1BetaDimson60m2BetaDimson60m3BetaDimson60m4BetaDimson60m5RelativeJ203TRelative to J203T
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Dimson Betas - weekly
Dec-84
Dec-85
Dec-86
Dec-87
Dec-88
Dec-89
Dec-90
Dec-91
Dec-92
Dec-93
Dec-94
Dec-95
Dec-96
Dec-97
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
0.016
0.156
1.563
15.625
156.250
5.7%
15.3%
19.0%19.5%20.8%
-12.5%
15.8%
-8.7%
BetaDimson104w1BetaDimson104w2BetaDimson104w3BetaDimson104w4BetaDimson104w5RelativeJ203TRelative to J203T
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Volatility - Daily
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Summary of Results
Annualised returns for equal weighted portfolio quintiles over the period 31Dec1986 - 31Dec2011
Risk MeasureNumber of Obs
ALSI Index R203
Highest Beta
QuintileQuintile
2Quintile
3Quintile
4
Lowest Beta
QuintileOLS Monthly Beta 60 15.7% 7.7% 12.1% 18.1% 21.6% 20.4%OLS Weekly Beta 104 15.7% 4.6% 15.4% 20.4% 19.9% 19.3%Dimson Monthly Beta 60 15.7% 7.9% 16.3% 19.3% 19.0% 17.4%Dimson Weekly Beta 104 15.7% 5.7% 15.3% 19.0% 19.5% 20.8%Volatility Daily 60 15.7% 9.7% 13.5% 17.7% 20.8% 18.2%Average annualised Return 15.7% 7.1% 14.5% 18.9% 20.2% 19.2%
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Dec 8
4
Dec 8
5
Dec 8
6
Dec 8
7
Dec 8
8
Dec 8
9
Dec 9
0
Dec 9
1
Dec 9
2
Dec 9
3
Dec 9
4
Dec 9
5
Dec 9
6
Dec 9
7
Dec 9
8
Dec 9
9
Dec 0
0
Dec 0
1
Dec 0
2
Dec 0
3
Dec 0
4
Dec 0
5
Dec 0
6
Dec 0
7
Dec 0
8
Dec 0
9
Dec 1
0
Dec 1
1
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
1.80
Portfolio 1 (Beta VH)
Portfolio 2 (Beta H)
Portfolio 3 (Beta M)
Portfolio 4 (Beta L)
Portfolio 5 (Beta VL)
Style: BetaOLS60m
Characteristic: BetaOLS60m
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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.
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Questions…
• For those interested:• The full paper will be published in the forthcoming:
– Investment Analyst Journal– http://www.iassa.co.za/journals/