capital asset pricing model versus arbitrage pricing theory

74 Pages·2016·1.2 MB·English

Masaryk University
Faculty of Economics and Administration
Field of study: Finance

CAPITAL ASSET PRICING MODEL
VERSUS ARBITRAGE PRICING THEORY
Diploma Thesis
Thesis Supervisor: Author:
Ing. Dagmar Linnertová, Ph.D. Bana Musharbash
Brno, 2016
MASARYK UNIVERSITY
Faculty of Economics and Administration

MASTER’S THESIS DESCRIPTION

Academic year: 2015/2016

Student: Bana Musharbash

Field of Study: Finance (eng.)

Title of the thesis/dissertation: A comparison between CAPM and APT

Title of the thesis in English: A comparison between CAPM and APT

Thesis objective, procedure and methods used: The thesis aim is to compare two models; CAPM and APT, in order
to find out which model is better for a prediction of stock returns on

the stock market.

Process of Work:

1. Introduction

2. Theoretical Methodology

3. Theoretical Framework

4. Conclusion, results and discussion

Methods:analysis, comparison, deduction
Extent of graphics-related work: According to thesis supervisor’s instructions

Extent of thesis without supplements: 60 – 80 pages
Literature: ANDREAS, S and M AUSTIN. An Empirical Comparison of Alternative

Models of Capital Asset Pricing in Germany. , 1992, roč. 16, č. 1.

ABEYSEKERA, S P and A MAHAJAN. International Arbitrage Pricing
Theory: An Empirical Investigation. SOUTHERN ECONOMIC JOUR-
NAL, CHAPEL HILL: UNIV NORTH CAROLINA, 1990, roč. 56, č. 3.

ISSN 0038-4038.

BLACK, F. International Capital Market Equilibrium with Investment

Barriers. Journal of Financial Economics, 1974, roč. 1, č. 4.

BLACK, F., M.C. JENSEN and M.S. SCHOLES. The Capital Asset Pri-
cing Model: Some Empirical Tests. In Studies in the Theory of Capital

Markets. : Praeger Publishers Inc., 1972. s. 79-121.

ABDYMOMUNOV, A and Morley J AMP. Time Variation of CAPM
Betas across Market Volatility Regimes. Applied Financial Econo-

mics, 2011, roč. 21, č. 19.

Thesis supervisor: Ing. Dagmar Linnertová, Ph.D.

Thesis supervisor’s department: Department of Finance

Thesis assignment date: 2015/04/14

The deadline for the submission of Master’s thesis and uploading it into IS can be found in the academic year calendar.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
prof. Ing. Antonín Slaný, CSc. dean

Head of department
In Brno, date: 2016/05/11

Abstract

This work is dedicated to the study of the Capital Asset Pricing Model and the Arbitrage
Pricing Theory model. The first part is the theoretical one; which describes the theoretical
background of each model and illustrates their mathematical derivations, then previous
empirical tests performed on the models as well as some of their alternative versions are
discussed.
The practical part describes the time-series regression analyses carried out for each model, the
results of which are analyzed and a comparison between the CAPM and the APT model is
made.

Key words

CAPM, APT, empirical test, time-series, regression analysis, beta coefficient, security market
line, risk factors, factor loading.

I
Statement of Authorship

I hereby declare that the Master thesis “Capital Asset Pricing Model Versus Arbitrage Pricing
Theory” and relevant research in its background is entirely my own work, supervised by Ing.
Dagmar Linnertová, Ph.D., and has not been taken out of the work from others. The used
literary resources and other specialist resources have been cited and acknowledged within the
text of the thesis and listed in the References according to the relevant legislation and
regulation.

In Brno____________ ________________
Bana Musharbash

II
Table of Contents

INTRODUCTION ................................................................................................................. 11
THEORETICAL BACKGROUND ....................................................................................... 14
Modern Portfolio Theory .................................................................................................. 14
The Capital Asset Pricing Model ...................................................................................... 20
Previous Empirical Studies of the Capital Asset Pricing Model....................................... 25
The Arbitrage Pricing Theory ........................................................................................... 28
Previous Empirical Studies of the Arbitrage Pricing Theory............................................ 32
The German Financial System and the German Financial Market ................................... 35
Changes to the German Financial System ........................................................................ 36
Impact of the Financial Crisis in Germany ....................................................................... 36
DAX Performance Index ................................................................................................... 39
Empirical Tests and Findings ................................................................................................ 40
Methodology ..................................................................................................................... 40
Data Selection ................................................................................................................... 40
Statistical Examination of Tested Data ............................................................................. 41
Testing of the Standard Capital Asset Pricing Model ............................................................ 44
Methodology of the Empirical Tests ..................................................................................... 45
Testing the Model ............................................................................................................. 46
Empirical Results ................................................................................................................... 47
Periodic CAPM ...................................................................................................................... 49
Pre- crisis Period ............................................................................................................... 49
Crisis Period ...................................................................................................................... 51
Post-Crisis Period .............................................................................................................. 52
Testing of the Arbitrage Pricing Theory ................................................................................ 54
Methodology of the Empirical Tests ..................................................................................... 55
Empirical Results ................................................................................................................... 56
Periodic APT .......................................................................................................................... 57
Pre-Crisis Period ............................................................................................................... 57
Crisis Period ...................................................................................................................... 58
Post-Crisis Period .............................................................................................................. 59
Summary ................................................................................................................................ 61
CONCLUSION ...................................................................................................................... 65
III
REFERENCES ....................................................................................................................... 67
APPENDICES ........................................................................................................................ 70
Appendix 1 ......................................................................................................................... 71

IV
List of Tables
Table 1: Companies currently listed on the DAX performance index 29.
Table 2: Statistical characteristics of the market index (DAX) 31.
Table 3: Regression results for the period March, 2001- December, 2015 for
certain securities 37.
Table 4: Pre-crisis period regression results 48.
Table 5: Crisis period regression results 49.
Table 6: Post-crisis period regression results 50.
Table 7: Summary of results for the entire testing period 51.
Table 8: Summary of results for pre-crisis period 52.
Table 9: Summary of results for crisis period 53.

Table 10: Summary of results for post-crisis period 53.

List of Figures
Figure 1: Probability distribution for two different investments with the same
expected return 4.
Figure 2: How diversification reduces risk 6.
Figure 3: Combination line for securities A and B for the case of zero correlation 7.
Figure 4: Choices of investors with different indifference curves 8.
Figure 5: Investment Opportunities 11.
Figure 6: The Capital Asset Pricing Model 14.
Figure 7: Arbitrage Pricing Line 21.
Figure 8: The Security Market Line (SML) 38.
Figure 9: Pre-Crisis Period SML 40.
Figure 10: Crisis Period SML 41.
Figure 11: Post-Crisis Period SML 42.

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