An Analysis of the Relationship between Risk and Expected Return in Malaysia Stock Market: Test of the CAPM

  • Authors

    • Koh Xin Rui
    • Devinaga Rasiah
    • Yuen Yee Yen
    • Suganthi Ramasamy
    • Shalini Devi Pillay
    2018-08-08
    https://doi.org/10.14419/ijet.v7i3.21.17154
  • Risk, Return, CAPM, Beta (β), Systematic Risk, Unsystematic Risk
  • Abstract

    Investment theory describes the concept of relationship between risk and return. Capital Model Asset Pricing Model (CAPM) was based on the risk and return relationship. CAPM described that asset’s expected return that is above the risk free rate is directly related to the non-diversifiable risk that is measure by beta. Focus of this study is to identify the impacts of risk toward the stock return in Malaysia stock market during the year 2007 to 2015 by testing on the applicability of Capital Asset Pricing Model. The data is from monthly stock returns from 24 companies listed on the stock exchange for investigation. The analysis of monthly stock market closing indexes from using regression model was carried out on the standard CAPM model. When testing the CAPM model for the whole period, it has not showed strong evidence that support the validity of this model and in order to get better estimates, this study divided the whole sample into 3 sub periods of five years each. The study found high beta value does not related to higher level in stock return. The positive relationship between systematic risk and return does not have a strong evidence to support it. The research also identify that the securities market line has direct relationship between risk and return. The unsystematic risk does not have an effect on the return. It means that stock prices cannot be effectively predicted by CAPM and Malaysia Stock and the validity of CAPM does not exist in Malaysia Stock Exchange Market for the period 2007-2015 due to some limitations such as time frame, sample size and others. This paper suggest a different assets pricing model and takes into consideration of some related variables in predicting future stocks returns. This research provides important implication to investors, analysts, stock brokers, speculators, fund managers, practitioners, relevant authorities, and government.

     

     

  • References

    1. style='font-size:8.0pt;background:white'>
    2. style='mso-spacerun:yes'> ADDIN EN.REFLIST
    3. field-separator'>[1] Clare AD, Priestley R. Risk factors in the Malaysian stock market. Pacific-Basin Finance Journal. 1998;6(1-2):103-14.

      [2] Berdica K. An introduction to road vulnerability: what has been done, is done and should be done. Transport policy. 2002;9(2):117-27.

      [3] Rackwitz R. Reliability analysis—a review and some perspectives. Structural safety. 2001;23(4):365-95.

      [4] Chen N-F, Roll R, Ross SA. Economic forces and the stock market. Journal of business. 1986:383-403.

      [5] Dempsey M. The capital asset pricing model (CAPM): the history of a failed revolutionary idea in finance? Abacus. 2013;49(S1):7-23.

      [6] Heshmat NA. Analysis of the capital asset pricing model in the Saudi stock market. International Journal of Management. 2012;29(2):504.

      [7] Markowitz HM, Todd GP, Sharpe WF. Mean-variance analysis in portfolio choice and capital markets: John Wiley & Sons; 2000.

      [8] Tehranian H, Cornett MM, Marcus AJ, Saunders A. Earnings management, corporate governance, and true financial performance. 2006.

      [9] Mitchell M, Pulvino T. Characteristics of risk and return in risk arbitrage. the Journal of Finance. 2001;56(6):2135-75.

      [10] Goldenberg DH, Robin AJ. THE ARBITRAGE PRICING THEORY AND COSTâ€OFâ€CAPITAL ESTIMATION: THE CASE OF ELECTRIC UTILITIES. Journal of Financial Research. 1991;14(3):181-96.

      [11] Ross S. Arbitrage, Risk Return in Finance ed. I. Friend and J Bicksler, Cambridge, Mass: Ballinger. 1976.

      [12] Stambaugh RF. Arbitrage pricing with information. Journal of Financial Economics. 1983;12(3):357-69.

      [13] CHEN NF. Some empirical tests of the theory of arbitrage pricing. The Journal of Finance. 1983;38(5):1393-414.

      [14] Chamberlain G. Funds, factors, and diversification in arbitrage pricing models. Econometrica: Journal of the Econometric Society. 1983:1305-23.

      [15] Ross S, Westerfield R, Jordan B. Fundamentals of Corporate Finance. McGrawHill. Google Scholar. 2013.

      [16] Van Horne J. Fundamentals of Financial Management/James C. Van Horne, John M. Wachowicz, Jr.–.–Harlow (England). London, New York: Prentice Hall Inc., Financial Times; 2008.

      [17] Brigham EF, Houston JF. Fundamentals of financial management: Cengage Learning; 2012.

      [18] Bodie Z, Kane A, Marcus AJ. Ready Notes to Accompany Essentials of Investments: McGraw-Hill Europe; 2005.

      [19] Drehmann M, Sorensen S, Stringa M. The integrated impact of credit and interest rate risk on banks: an economic value and capital adequacy perspective. 2008.

      [20] Lajeri F, Dermine J. Unexpected inflation and bank stock returns: The case of France 1977–1991. Journal of Banking & Finance. 1999;23(6):939-53.

      [21] Flannery MJ, Hameed AS, Harjes RH. Asset pricing, time-varying risk premia and interest rate risk. Journal of Banking & Finance. 1997;21(3):315-35.

      [22] Lloyd WP, Shick RA. A test of Stone's two-index model of returns. Journal of Financial and Quantitative Analysis. 1977;12(3):363-76.

      [23] Fisher R. The Genetical Theory of Natural Selection Oxford University Press Oxford Google Scholar. 1930.

      [24] Uwubanmwen A, Eghosa IL. Inflation Rate and Stock Returns: Evidence from the Nigerian Stock Market. International Journal of Business and Social Science. 2015;6(11):155-67.

      [25] Adler M, Dumas B. Exposure to currency risk: definition and measurement. Financial management. 1984:41-50.

      [26] Hussain N, Khan AQ. An Analysis of the Stock Return and Exchange Rate Variation on Market Return of Pharmaceutical Industry in Pakistan. World Applied Sciences Journal. 2014;31(6):1180-7.

      [27] Michailidis G, Tsopoglou S, Papanastasiou D. Testing the capital asset pricing model (CAPM): The case of the emerging Greek securities market. 2006.

      [28] Li X, Miffre J, Brooks C, O’Sullivan N. Momentum profits and time-varying unsystematic risk. Journal of Banking & Finance. 2008;32(4):541-58.

      [29] Yuanjun Z, Zengrui T. Research on evaluation of venture capital fund project based on data envelopment analysis model. Journal of Computational and Theoretical Nanoscience. 2016;13(2):1266-74.

      [30] Hasan MZ, Kamil AA, Mustafa A, Baten MA. Relationship between risk and expected returns: Evidence from the dhaka stock exchange. Procedia Economics and Finance. 2012;2:1-8.

      [31] Olakojo S, Ajide K. Testing the Capital Asset Pricing Model (СÐÐ Ðœ): The Case of the Nigerian Securities Market. International Business Management. 2010;4(4):239-42.

      [32] Damodaran A. Investment valuation, 2. Aufl, New York. 2002;817.

      [33] Fama EF, French KR. The crossâ€section of expected stock returns. the Journal of Finance. 1992;47(2):427-65.

      [34] Amihud Y, Christensen BJ, Mendelson H. Further evidence on the risk-return relationship: Graduate School of Business, Stanford University; 1992.

      [35] Kothari SP, Shanken J, Sloan RG. Another look at the crossâ€section of expected stock returns. The journal of finance. 1995;50(1):185-224.

      [36] Chan LK, Lakonishok J. Robust measurement of beta risk. Journal of financial and quantitative analysis. 1992;27(2):265-82.

      [37] Salman F. Risk-Return-Volume relationship in an Emerging Stock Market. Applied Economics Letters 9. 2002:549-52.

      [38] Omet G, Khasawneh M, Khasawneh J. Efficiency Tests and Volatility Effects: Evidence from the Jordanian Stock Market. Applied Economics Letters 9(12). 2002:817-21.

      [39] Li X, Miffre J, Brooks C, O’Sullivan N. Momentum profits and time-varying unsystematic risk. Journal of Banking and Finance. 2008;32:541-58.

      [40] Chui A, Titman S, Wei J. Individualism and momentum around the world. Journal of Finance. 2010;65:361-92.

      [41] Fama EF, MacBeth JD. Risk, return, and equilibrium: Empirical tests. Journal of political economy. 1973;81(3):607-36.

      [42] Sharpe WF, Cooper GM. Risk-return classes of New York stock exchange common stocks, 1931–1967. Financial Analysts Journal. 1972;28(2):46-54.

      [43] Basher SA, Sadorsky P. Oil price risk and emerging stock markets. Global finance journal. 2006;17(2):224-51.

      [44] Banz RW. The Relationship Between Return and Market Value ofCommon Stock. Journal of Finance Economics 9:1. 1981:3-18.

      [45] Gibbons MR. Multivariate Tests of Financial Models: A new Approach. Journal of Financial Economics 10:1. 1982:3-27.

      [46] Stambaugh RF. On the Exclusion of Assets from Tests from the Two Parameter Model: A sensitivity Analysis. Journal of Financial Economic 10:3. 1982:237-68.

      [47] Bilgin R, Basti E. Further Evidence on the Validity of CAPM: the Istanbul Stock Exchange Application. Inzinerine Ekonomika-Engineering Economics. 2014;25(1):5-12.

      [48] Salman F. Risk-return-volume relationship in an emerging stock market. Applied Economics Letters. 2002;9(8):549-52.

      [49] Alqisie A. Validity of Capital Assets Pricing Model (CAPM) (Empirical Evidences from Amman Stock Exchange). Journal of Management Research. 2016;8(1).

      [50] Ball R, Brown P, Officer R. Asset Pricing in the Australian Industrial Equity Market. Australian Journal of Management, 1(1). 1976:1-32.

      [51] Fama E, French k. Multi-factor explanations of asset pricing anomalies. Journal of Finance. 1996;51:55-84.

      [52] Theriou N, Aggelidis V, Maditinos D, Sevic Z. l.(2010). Testing the relation between beta and returns in the Athens stock exchange. Managerial Finance.36(12):1043-56.

      [53] Gürsoy CT, Rejepova G. Test of capital asset pricing model in Turkey. 2007.

      [54] Groenewold N. FORECASTING BETA: HOW WELL DOES THE ‘FIVE-YEAR RULE OF THUMB’ DO? 1999.

      [55] Elton EJ, Gruber MJ, Brown SJ, Goetzmann WN. Modern portfolio theory and investment analysis: John Wiley & Sons; 2009.

      [56] Bodie Z, Kane A, Marcus AJ. Investments: McGraw-Hill; 2009.

      [57] Czekierda B. The Capital Asset Pricing Model: Test of the model on the Warsaw Stock Exchange. Institutionen för Ekonomi,Statistik och Informatik. 1976:1-57.

      [58] Reinganum MR. Misspecification of capital asset pricing: Empirical anomalies based on earnings' yields and market values. Journal of financial Economics. 1981;9(1):19-46.

      [59] Banz RW. The relationship between return and market value of common stocks. Journal of financial economics. 1981;9(1):3-18.

      [60] Gibbons MR. Multivariate tests of financial models: A new approach. Journal of financial economics. 1982;10(1):3-27.

      [61] Lau ST, Lee CT, McInish TH. Stock returns and beta, firms size, E/P, CF/P, book-to-market, and sales growth: evidence from Singapore and Malaysia. Journal of multinational financial management. 2002;12(3):207-22.

      [62] Alqisie A, Alqurran T. Validity of Capital Assets Pricing Model (CAPM)(Empirical Evidences from Amman Stock Exchange). Journal of Management Research. 2016;8(1):207-23.

      [63] Estrada J. The cost of equity in emerging markets: a downside risk approach. 2000.

      [64] Cheung Y-L, Wong K-A, Ho Y-K. The pricing of risky assets in two emerging Asian markets—Korea and Taiwan. Applied Financial Economics. 1993;3(4):315-24.

      [65] Isa M, Hassan A, Puah C-H, Yong Y-K. Risk and return nexus in Malaysian stock market: Empirical evidence from CAPM. 2008.

      [66] Lee HS, Cheng FF, Chong SC. Markowitz Portfolio Theory and Capital Asset Pricing Model for Kuala Lumpur Stock Exchange: A Case Revisited. International Journal of Economics and Financial Issues. 2016;6(S3) 59-65.

      [67] Kolani P, Vikpossi AE. An Analysis of the Relationship between Risk and Expected Return inthe BRVM Stock Exchange: Test of the CAPM. Published by Sciedu Press; 2014.

      [68] Ball R, Brown P, Officer R. Asset pricing in the Australian industrial equity market. Australian Journal of Management. 1976;1(1):1-32.

      [69] Michailidis G, Tsopoglou S, Papanastasiou D, Mariola E. Testing the capitalasset pricing model (capm): the case of the emerging Greek securities market. International Research Journal of Finance and Economics. 2006;4:78-91.

      [70] Pamane K, Vikpossi AE. An analysis of the relationship between risk and expected return in the BRVM stock exchange: test of the CAPM. Research in World Economy. 2014;5(1):13.

      [71] Isakov D. Is beta still alive? Conclusive evidence from the Swiss stock market. The European Journal of Finance. 1999;5(3):202-12.

      [72] Tang GY, Shum WC. The relationships between unsystematic risk, skewness and stock returns during up and down markets. International Business Review. 2003;12(5):523-41.

      [73] Fletcher GP. Rethinking criminal law: Oxford University Press; 2000.

      [74] Malaysia’s Economy. Sarawak Score [Internet]. 2016. Available from: http://www.recoda.com.my/inside-sarawak/malaysias-economy/.

      [75] Ng F. Malaysia’s looming economic woes. TheStar Online [Internet]. 2016 May 14. Available from: http://www.thestar.com.my/business/business-news/2016/05/14/malaysias-looming-economic-woes/.

      [76] Hasan M, Kamil AA, Mustafa A, Baten MA. A validity test of capital asset pricing model for Dhaka stock exchange. Journal of Applied Sciences. 2011;11(20):3490-6.

      [77] Lee H-S, Ng DC-Y, Lau T-C, Ng C-H. Forecasting Stock Market Volatility on Bursa Malaysia Plantation Index. International Journal of Finance and Accounting. 2016;5(1):54-61.

      [78] Arslan M, Zaman R. Impact of Dividend Yield and Price Earnings Ratio on Stock Returns: A Study Non-Financial listed Firms of Pakistan. Research Journal of Finance and Accounting. 2014;5(9):68-74.

      [79] Al-Mwall M, Ahmed AM, A.Fayssal. The Relationship between P/E Ratio, Dividend Yield Ratio,Size and Stock Returns in Jordanian Companies: A Co-integration Approach. International Research Journal of Finance and Economics. 2010;49(7):87-103.

      [80] Raymond YC. Price-Earnings Ratios, Dividend Yields and Real Estate Stock Prices. Journal of Real Estate Portfolio Management. 2002;8(2):107-13.

      [81] Pettengill GN, Sundaram S, Mathur I. The Conditional Relation between Beta and Returns. Journal of Financial and Quantitative Analysis. 1995;30:101-16.

      [82] Andersen TG, Bollerslev T, Diebold FX, Wu G. Realized beta: Persistence and predictability. Econometric Analysis of Financial and Economic Time Series: Emerald Group Publishing Limited; 2006. p. 1-39.

    4. mso-fareast-font-family:Batang;background:white;mso-ansi-language:EN-US;
    5. mso-fareast-language:KO;mso-bidi-language:AR-SA'>
  • Downloads

  • How to Cite

    Xin Rui, K., Rasiah, D., Yee Yen, Y., Ramasamy, S., & Devi Pillay, S. (2018). An Analysis of the Relationship between Risk and Expected Return in Malaysia Stock Market: Test of the CAPM. International Journal of Engineering & Technology, 7(3.21), 161-170. https://doi.org/10.14419/ijet.v7i3.21.17154

    Received date: 2018-08-08

    Accepted date: 2018-08-08

    Published date: 2018-08-08