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An Analysis of the Relationship between Risk and Expected Return in the BRVM Stock Exchange: Test of the CAPM

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  • Kolani Pamane
  • Anani Ekoue Vikpossi

Abstract

One of the most important concepts in investment theory is the relationship between risk and return. This relationship drives the theoretical foundation of many investment models such as the well known Capital Asset Pricing Model which predicts that the expected return on an asset above the risk-free rate is linearly related to the non-diversifiable risk measured by its beta. This study examines the Capital Asset Pricing Model (CAPM) and test it validity for the WAEMU space stock market called BRVM (BOURSE REGIONALE DES VALEURS MOBILIERES) using monthly stock returns from 17 companies listed on the stock exchange for the period of January 2000 to December 2008. Combining Black, Jensen and Scholes with Fama and Macbeth methods of testing the CAPM, the whole period was divided into four sub-periods and stock¡¯s betas used instead of portfolio¡¯s betas due to the small size of the sample. The CAPM¡¯s prediction for the intercept is that it should equal zero and the slope should equal the excess returns on the market portfolio. The results of the study refute the above hypothesis about the slope and offer evidence against the CAPM for all the sub-period and even for the whole period. The tests conducted to examine the nonlinearity of the relationship between return and betas support the hypothesis that the expected return-beta relationship is linear. Additionally, this paper investigates whether the CAPM adequately captures all-important determinants of returns including the residual variance of stocks.The results demonstrate that residual risk has no effect on the expected returns of stocks for the whole period and the entire sub ¨Cperiods except for the last period of 2003-2008 which shows that returns are affected by non-systematic risks during that specific period, justifying the fact that the operating activities of the firms have an impact on their stocks returns.

Suggested Citation

  • Kolani Pamane & Anani Ekoue Vikpossi, 2014. "An Analysis of the Relationship between Risk and Expected Return in the BRVM Stock Exchange: Test of the CAPM," Research in World Economy, Research in World Economy, Sciedu Press, vol. 5(1), pages 13-28, March.
  • Handle: RePEc:jfr:rwe111:v:5:y:2014:i:1:p:13-28
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    References listed on IDEAS

    as
    1. Backus, David K & Gregory, Allan W, 1993. "Theoretical Relations between Risk Premiums and Conditional Variances," Journal of Business & Economic Statistics, American Statistical Association, vol. 11(2), pages 177-185, April.
    2. Pettengill, Glenn N. & Sundaram, Sridhar & Mathur, Ike, 1995. "The Conditional Relation between Beta and Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(1), pages 101-116, March.
    3. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, March.
    4. John Lintner, 1965. "Security Prices, Risk, And Maximal Gains From Diversification," Journal of Finance, American Finance Association, vol. 20(4), pages 587-615, December.
    5. Hossein Asgharian & Björn Hansson, 2000. "Cross‐sectional analysis of Swedish stock returns with time‐varying beta: the Swedish stock market 1983–96," European Financial Management, European Financial Management Association, vol. 6(2), pages 213-233, June.
    6. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    7. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    8. Merton, Robert C., 1980. "On estimating the expected return on the market : An exploratory investigation," Journal of Financial Economics, Elsevier, vol. 8(4), pages 323-361, December.
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    Keywords

    CAPM; beta; BRVM stock exchange; risk; expected return;

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