The present study aims to see whether the Capital Asset Pricing Model (CAPM) offers an appropriate explanation of stock returns in the Indian capital markets and whether higher risk (beta) brings higher level of return. The sample in the present study consists of 320 actively traded scripts listed in the Bombay Stock Exchange (BSE). The scripts in the sample are selected from a range of industries. Month-end prices (last trading day of the calendar month) have been used to compute the holding period return for each month for the entire 7-year period of the study (from 1998 to 2004). The Sensex, BSE-100 and BSE-200 stock indexes are used as representatives for the market portfolio (market index) in the study. The testing consists of two sets of regression. In the first set, beta is estimated for all scripts in the sample using a time series regression method. In the second set, the estimated betas from the first-pass regression are used to test the validity of the model in a cross-sectional regressioregression.
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