An Empirical Test of the Validity of

Conventional Capital Assets Pricing Model in the

context of Nepal Stock Exchange

Presented By

Bishal Shrestha
M.Phil_2018_Roll_No_18615
KUSOM
Feb 2019
Background and Introduction
• A fundamental question in finance is how the risk of an investment should
affect its expected return (Perold, F., 2004).

• Sharpe (1964), Linter (1965) and Mossin (1966) based on work of

Markowitz(1952) provided simple yet powerful tool to establish the
relationship between asset’s return and its risk, which is famously known as
the Capital Assets Pricing Model (CAPM).

• CAPM has provided investor with an intuitively powerful tools in terms of

pricing any assets based on level of risk involved therein. (Fama & French.,
2004)
Problem Statement
• Earlier empirical studies of CAPM showed that there existed a linear
relationship between expected return and systematic component of risk
measured by beta (Miller & Scholes, 1972; Black et al., 1972; Fama &
Macbeth, 1973), These findings were taken as evidence in support of
the CAPM.
• However, findings in later studies (Roll 1977, 1978; Davis, 1994;
Miles & Timmermann, 1996) showed a mixed result on CAPM’s
predictive power of assets expected return based on its’ risk
component.
• Contradictory results of past studies on empirical validity of
conventional CAPM model on predicting the relationship between risk
and return arises a concern whether the model is applicable in the
context of Nepalese or not.
Research Question

Whether the relationship between ex-ante excess expected return on

assets and expected excess return on market portfolio is fully mediated
by systematic risk component as postulated by conventional CAPM in
the context of securities listed in NEPSE?
Objective of the Study

The objective of this research will be to examine the empirical validity

of conventional CAPM to test the extent of relationship between
expected excess return on market portfolio and expected excess return
on assets mediated by systematic risk factor as modeled by conventional
CAPM.
 Conceptual Model

Hypotheses:
H 1: Systematic risk factor, measured by beta fully mediates the
relationship between expected excess return on market portfolio and
expected excess return on assets for securities listed in NEPSE.
Research Methodology

• Research Design :- Longitudinal Research Design.

Time series regression analysis method will be used to test the validity
of proposed model.

• Variables and Unit of Analysis:

Variable of Interest: - Expected return on assets, expected return
on market, systematic risk factor
Unit of Analysis: - Individual assets (stocks) and Portfolios
Research Methodology
• Population and Sample: - The population of this study includes all the
stocks listed in Nepal Stock Exchange (NEPSE) over the period of 1st
Shrawan 2065 to 31st Ashad 2075.

• Sampling Design: - The sample consists of all the stocks listed in

NEPSE over the period of 1st Shrawan 2065 to 31st Ashad 2075. This
study purposively included all the securities listed in NEPSE so as to
avoid any exclusion bias.
Intuitive reason behind exclusion of any particular securities/stock is
to avoid the influence on estimation of excess return on market
portfolio and ranking procedure.
Research Methodology

Data Processing and Analysis: - To analyze the secondary data and for
model fit test, this study will adopt the methodology used by Black et al.
which was used to test empirical validity of conventional CAPM on
securities listed in New York Stock Exchange published in 1972 in
article named “The Capital Assets Pricing Model: Some Empirical
Test”.
Expected Outcome

Time-series regression analysis used in this study will disclose a

correlational aspect of expected return and systematic risk. Though, the
causality effect cannot be established, the observed relation from study
will enable management, investor(s) and institution(s) on deciding the
degree of reliance to be placed on expected return on assets used for
investment decisions.
Limitation
• Various restrictive and undoubtedly unrealistic assumptions (Sharpe,
1964; p.434) of proposed model developed in western context might
be partially or completely absent in the context of Nepal

• Application of time series regression method using secondary data set

is expected to contain various limitation inherent to such method and
sources.

• Findings of this research lacks generalizability due to limited span of

time covered under study.
Managerial Implication

• Fund management is the integral part of financial management.

Financial models and tools always helped financial managers in taking
informed and financially optimal decision.
• The findings of this study will test the empirical validity of most used
financial tools for investment decision by managers till date.
• This research findings will present the validity of Capital Assets
Pricing Model which will enable financial managers to evaluate their
decision made on the basis of such model.
Research Implication

• This study focuses on validity of conventional model proposed by

Sharpe (1964) which underwent various alteration and modification
over the period of many decades. Thus, it is imperative to conduct
more studies to examine whether variations of CAPM holds in the
context of Nepal’s capital market.
Thank You!!