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Risk-return relationship: An empirical study of different statistical methods for estimating the Capital Asset Pricing Models (CAPM) and the Fama-French model for large cap stocks

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  • Linh Nghiem

Abstract

The Capital Asset Pricing Model (CAPM) is one of the original models in explaining risk-return relationship in the financial market. However, when applying the CAPM into reality, it demonstrates a lot of shortcomings. While improving the performance of the model, many studies, on one hand, have attempted to apply different statistical methods to estimate the model, on the other hand, have added more predictors to the model. First, the thesis focuses on reviewing the CAPM and comparing popular statistical methods used to estimate it, and then, the thesis compares predictive power of the CAPM and the Fama-French model, which is an important extension of the CAPM. Through an empirical study on the data set of large cap stocks, we have demonstrated that there is no statistical method that would recover the expected relationship between systematic risk (represented by beta) and return from the CAPM, and that the Fama-French model does not have a better predictive performance than the CAPM on individual stocks. Therefore, the thesis provides more evidence to support the incorrectness of the CAPM and the limitation of the Fama-French model in explaining risk-return relationship.

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  • Linh Nghiem, 2015. "Risk-return relationship: An empirical study of different statistical methods for estimating the Capital Asset Pricing Models (CAPM) and the Fama-French model for large cap stocks," Papers 1511.07101, arXiv.org.
    • Handle: RePEc:arx:papers:1511.07101
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    References listed on IDEAS

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    1. Issouf Soumar� & Edoh Kossi Am�nounv� & Ousmane Diop & Dramane M�it� & Yao Djifa N'sougan, 2013. "Applying the CAPM and the Fama--French models to the BRVM stock market," Applied Financial Economics, Taylor & Francis Journals, vol. 23(4), pages 275-285, February.
    2. Paulo Alves, 2013. "The Fama French Model or the Capital Asset Pricing Model: International Evidence," The International Journal of Business and Finance Research, The Institute for Business and Finance Research, vol. 7(2), pages 79-89.
    3. Guzeldere, , Harun & Sarioglu, Serra Eren, 2012. "Validity of Fama-French Three-Factor Model In Asset Pricing: An Application In Istanbul Stock Exchange," Business and Economics Research Journal, Uludag University, Faculty of Economics and Administrative Sciences, vol. 3(2), pages 1-1, April.
    4. Frazzini, Andrea & Pedersen, Lasse Heje, 2014. "Betting against beta," Journal of Financial Economics, Elsevier, vol. 111(1), pages 1-25.
    5. Fama, Eugene F & French, Kenneth R, 1996. "Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    6. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    7. repec:bla:jfinan:v:59:y:2004:i:2:p:831-868 is not listed on IDEAS
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    Cited by:

    1. Sonia Di TOMASO & Denis Marco MONTAGNA & Antonio AMENDOLA, 2021. "Stock Returns and Cash Flows: A New Asset Pricing Approach," Journal of Economics and Financial Analysis, Tripal Publishing House, vol. 5(2), pages 85-120.

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