Forecasting performance of capital asset pricing models in case of Pakistani market

Javid, Attiya Yasmin (2008): Forecasting performance of capital asset pricing models in case of Pakistani market. Published in: The Business Review, Cambridge , Vol. II, (December 2008)

Abstract

This study empirically tests the conditional CAPM, conditional consumption CAPM and conditional multifactor CAPM model with individual stocks traded at Karachi Stock Exchange (KSE), the main equity market in Pakistan for the period 1993-2004. The ability of conditional CAPM models in forecasting asset returns is assessed through predictability of excess return for the period 2005-2006. The results show that the macroeconomic variables that capture business cycle fluctuations are better in explaining the cross-section variation in expected returns, they are found to have better forecasting ability for out-of-sample stock returns in case of Pakistani Market. The evaluation of forecasting ability of the conditional asset pricing models shows that the forecasting power of conditional multifactor CAPM is relatively better compared to conditional CAPM model and conditional consumption CAPM models. It follows, therefore, that the business cycle variables provide useful information for predicting the future direction of stock prices. These variables include market return, call money rate, term structure, industrial production growth, inflation rate, foreign exchange rate and growth in oil prices.

• Item Type: MPRA Paper
• Language: English
• Keywords: CAPM; Stock Exchange; Conditional Multifactor CAPM Model
• Subjects: A - General Economics and Teaching > A1 - General Economics

References

Angas. L. L. B., (1936) Investment For Appreciation-Forecasting Movement in Security Prices, Technique in Trading for Shares for Profit. London: Macmillian.

Campbell, John Y. (1987) Stock Returns and Term Structure. Journal of Financial Economics 18, 373–400.

Chen, Nai-Fu., Richard Roll, and Stephen A. Ross, (1986) Economic Forces and the Stock Market, Journal of Business 59, 383–403.

Cooper, Michael, Huseyin Gulen, and Maria Vassalou (2001) Investing in Size and Book–to-Market Portfolio using Information about the Macroeconomy: Some New Trading Rules. Working Paper.

Davidian, Marie and Raymond J. Carroll (1987) Variance Function Estimation. Journal of the American Statistical Association, 1079–1091.

Fama, Eugene F. and James D. MacBeth (1973) Risk, Return and Equilibrium: Empirical Tests. Journal of Political Economy, 81:3, 607–36.

Ferson, W. E. (1990) Are the Latent Variables in Time Varying Expected Returns Compensation for Consumption Risk? Journal of Finance 45, 397–430.

Ferson, Wayne E. and Campbell R. Harvey (1991) The Variation of Economic Risk Premiums. Journal of Political Economy, 99, 385–415.

Ferson, Wayne E. and Campbell R. Harvey (1993) The Risk and Predictability of International Equity Returns. Review of Financial Studies, 6, 527–566.

Ferson Wayne E. and Campbell R. Harvey (1999) Economic, Financial and Fundamental Global Risk In and Out of EMU. Swedish Economic Policy Review, 6, 123–184.

Iqbal, Javed, Robert Brooks and D. U. Galagedera (2008) Testing Conditional Asset Pricing Model: An Emerging Market Perspective. Working Paper 3/08, Monash University, Australia.

Javid, Attiya Yasmin (2008) Time Varying Risk Return Relationship Evidence from listed Pakistani Firms. International Research Journal of Finance and Economics, 18.

Shanken, Jay, (1992) On the Estimation of Beta Pricing Models. Review of Financial Studies 5, 1-34.

Schwert, William G. (1989) Why Does the Stock Price Volatility Change Over Time? Journal of Finance, 44, 1115- 1153.