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Testing the Validity of the Capital Asset Pricing Model in Turkey”

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Testing the Validity of the Capital Asset Pricing Model in Turkey” T.C. İstanbul Üniversitesi Sosyal Bilimler Enstitüsü İngilizce İktisat Anabilim Dalı Yüksek Lisans Tezi Testing The Validity of The Capital Asset Pricing Model In Turkey Veysel Eraslan 2504080001 Tez Danışmanı Prof. Dr. Nihal Tuncer İstanbul 2011 “Testing The Validity of The Capital Asset Pricing Model In Turkey” Veysel ERASLAN ÖZ Finansal Varlıkları Fiyatlandırma Modeli yıllardan beri akademisyenlerin üzerinde çalıştığı en popüler konulardan biri olmuştur. Finansal Varlıkları Fiyatlandırma Modeli’nin farklı ekonomilerdeki geçerliliğini test etmek amacıyla birçok çalışma yapılmıştır. Bu çalışmalarda modeli destekleyen veya desteklemeyen farklı sonuçlar elde edilmiştir. Bu çalışmada, Finansal Varlıkları Fiyatlandırma Modeli’nin Sharpe- Lintner-Black versiyonu, Ocak 2006-Aralık 2010 zaman dilimi içerisinde İstanbul Menkul Kıymetler Borsası aylık kapanış verileri kullanılarak test edilmiştir. Çalışmanın amacı modelde risk ölçüsü olarak ifade edilen portföy betası ile portföy getirisi arasındaki ilişkinin belirtilen zaman dilimi içerisinde İstanbul Menkul Kıymetler Borsası’nda test edilmesidir. Çalışmada iki farklı yöntem kullanılmıştır. Bunlardan birincisi koşulsuz (geleneksel) analiz yöntemidir. Bu yöntemin temelini Fama ve French’in (1992) çalışması oluşturmaktadır. İkinci yöntem olarak ise Pettengill v.d. nin (1995) koşullu analiz tekniği kullanılmıştır. Yapılan analizler sonucunda Finansal Varlıkları Fiyatlandırma Modeli’nin İstanbul Menkul Kıymetler Borsası’nda geçerli olduğu bulgusuna ulaşılmış olup betanın bir risk ölçüsü olarak kullanılabilirliği desteklenmiştir. ABSTRACT The Capital Asset Pricing Model has been the most popular model among the academicians for many years. Lots of studies have been done in order to test the validity of the Capital Asset Pricing Model in different economies. Various results were obtained at the end of these studies. Some of these results were supportive while some of them were not. In this study, the Sharpe-Lintner-Black version of the Capital Asset Pricing Model is tested in Istanbul Stock Exchange including the years starting from January 2006 through December 2010. The aim of the study is testing the relationship between beta and rate of return in Istanbul Stock Exchange during the given time period. Beta is used as the risk measure in the model. Two different approaches are used in the study. The first one is the unconditional approach which is based on the study by Fama and French (1992). The second approach is based on the work of Pettengill et al (1995). The empirical findings of these models reveal that the Capital Asset Pricing Model is applicable to Istanbul Stock Exchange and beta can be used as a useful measure of risk. iii PREFACE The Capital Asset Pricing Model (CAPM) has been the most popular model among the academicians for many years. Lots of studies have been done in order to test the validity of the CAPM in different economies. Different results are obtained at the end of these studies. Some of these results validate the CAPM while some of them do not. In this study, the Sharpe-Lintner-Black version of the CAPM is tested in the Istanbul Stock Exchange including the years starting from January 2006 to December 2010. The aim of the study is testing the relationship between portfolio betas and portfolio returns in ISE during the specified time period. Two different approaches are used in the study. The first one is the unconditional approach which is based on the study of Fama and French (1992). The unconditional approach requires that the periods in which the excess market-portfolio-returns are positive and negative are evaluated together. As a result of this evaluation it is found that the CAPM is not supported by the unconditional test. This bias is attributed to combining the positive excess market-portfolio-return and negative excess market-portfolio-return periods. To avoid this bias, in the second model, based on the work of Pettengill et al. (1995), positive excess market return and negative excess market return periods are separated from each other. Test results of the second model reveal that excess portfolio returns and portfolio betas are positively related when the excess market-portfolio-return is positive and negatively related when the excess market-portfolio-return is negative. That is to say, higher beta portfolios attract higher excess returns when the excess market-portfolio- return is positive and higher beta portfolios attract lower excess returns when the excess market-portfolio-return is negative. This result proves the existence of a systematic-conditional relationship between portfolio betas and portfolio returns. As a result, we conclude that the CAPM is applicable to ISE and beta can be used as a useful measure of risk. I would like to express my special thanks to my advisor Prof. Dr. Nihal Tuncer and Assist. Prof. Dr. Salvatore J. Terregrossa for their great help. I also thank to iv Assist. Prof. Dr. Yasin Barış Altaylıgil for his help. I also thank to my family for their continued support. v LIST OF TABLES Page Table 1 : Test Results and Average Excess Returns (Unconditional) ………………………………………………………………47 Table 2 : Coefficient of Determination Values (Unconditional)……..48 Table 3 : Portfolio Betas and Average Excess Portfolio-Returns (Conditional-Positive)………………………………….…...49 Table 4 : Portfolio Betas and Average Excess Portfolio-Returns (Conditional-Negative)……………………………….…….50 Table 5 : Test Results of the Model 1……..…………………………54 Table 6 : Test Results of the Model 2………..………………………55 vii LIST OF FIGURES Page Figure 1 : TheCapital Allocation Line……………………………………....9 Figure 2 : The Efficient Frontier………………………………...……….…10 Figure 3 : The Capital Market Line and the Market Portfolio…………..….11 Figure 4 : The Sensitivity of Portfolio Return to the Market Return...........12 Figure 5 : The Security Market Line………………………………….….…14 Figure 6 : The Therotical SML and Empirically Estimated SML……….....16 Figure 7 :Excess Portfolio Return-Portfolio Beta Relationship (Unconditional)……………………………………………......….51 Figure 8 : Excess Portfolio Return-Portfolio Beta Relationship (Conditional-Positive)……………….………………...………….52 Figure 9 : Excess Portfolio Return-Portfolio Beta Relationship (Conditional-Negative)……………………………………...…....53 viii LIST OF ABBREVIATIONS APT : Arbitrage Pricing Theory ASE : Athens Stock Exchange CAL : Capital Allocation Line CAPM : Capital Asset Pricing Model CML : Capital Market Line ISE : Istanbul Stock Exchange NYSE : New York Stock Exchange SLB : Sharpe-Lintner-Black Model SML : Security Market Line TSE : Tokyo Stock Exchange ix INTRODUCTION After the specification of the Portfolio Theory by Markowitz, there have been many studies on the asset pricing issue. One of the first and the most important models regarding asset pricing is the Capital Asset Pricing Model (CAPM). The Sharpe- Lintner and Black (SLB) version of the CAPM has been the most popular model due to its testability in the various stock markets around the globe. There are many studies supporting the validity of the CAPM, while there have been some that attempt to invalidate the theory. Still, the CAPM remains an on-going, popular, and current topic in the literature. The goal of this thesis is testing the validity of the CAPM in Turkey, by using the models of Fama and French (1992) and Pettengill et al. (1995) with Turkish data. In order to test the CAPM, the SLB version of the model is tested with data from firms listed on the Istanbul Stock Exchange (ISE). The SLB version depicts a positive, linear relation between beta and expected portfolio returns, and is illustrated by the Security Market Line. The SLB version of the CAPM is tested in the present study with both the unconditional approach (of Fama and French (1992), and conditional approach (of Pettengill et al. (1995), respectively. In the unconditional approach, both positive and negative excess market-portfolio- return monthly data are combined into a single data set. With this approach, it is found that there is not a direct relationship between portfolio betas and average portfolio excess-returns. However, this finding does not necessarily invalidate the CAPM. As for the conditional approach, periods when the excess market-portfolio- return is positive, and periods when the excess market-portfolio-return is negative are evaluated separately. It is concluded in the result of the conditional approach that higher beta portfolios attract higher excess-returns when the excess market-portfolio- return is positive, and higher beta portfolios attract lower excess-returns when the excess market-portfolio-return is negative. This result is consistent with the basic 1 tenets of the CAPM. Thus, it is reasonably concluded that the CAPM is a valid model regarding firms listed on the ISE from January 2006 through December 2010, the years of the present study. 2 1. THEORY OF THE CAPITAL ASSET PRICING MODEL 1.1. Sharpe- Lintner-Black (SLB) Model The CAPM was born at a time when the effect of uncertainty on decision making was new and most of the investors were not aware of the theoretical part of the risk and return relationship in the capital market. The question of how the risk of an investment affects its return has been the basic concern of the investors. The CAPM- SLB has been the first solution to this problem. The model was developed by William Sharpe (1964), Jack Treynor (1961), John Lintner (1965), Jan Mossin(1966) and Fischer Black (1972). This model can be noted as the birth of the asset pricing theory also. The CAPM leads
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