CAPM Theory and Evidence

CAPM Theory and Evidence

The CAPM theory has developed with time. The CAPM asset pricing theory has gained wide application such as evaluating the performance of managed portfolios and estimating the cost of capital for organizations (Fama & French 1). The CAPM has gained wide application as it offers pleasing predictions on the way of measuring the risk and the relation between the rusk and the expected returns. This study will evaluate the CAPM in relation to the FTSE stock market.

The study calculates the pre ranking beta for every FTSE stock database at the end of the year (in December) for the years between 194 and 2015, for the five years of the prior month’s returns. Then the ten value weight portfolio is developed based on the pre-ranking of the bears. The returns for the portfolios for the next twelve months is then computed. This process is repeated for every year from the years 1984 to the year 2015 (Fama and French 4). After the calculation, there were 372 monthly returns on the ten beta-sorted portfolios. This is illustrated in the Figure 1.0 below. The figure plots the average refund foe each portfolio against the pre-ranking beta which is estimated by carrying out a regression of its monthly returns from the year 1984 to 2015 on the return of the value weight portfolio developed for the UK common stocks (Yahoo Finance, 2015)……………….

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