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Test of Multi-moment Capital Asset Pricing Model: Evidence from Karachi Stock Exchange

  • Attiya Y. Javid

    (Pakistan Institute of Development Economics, Islamabad)

  • Eatzaz Ahmad

    (Quaid-i-Azam University, Islamabad)

This study examines the Capital Asset Pricing Model of Sharpe (1964) Lintner (1965) and Black (1972) as the benchmark model in the asset pricing theory. The empirical findings indicate that the Sharpe-Lintner-Black CAPM inadequately, particularly the explains Pakistan’s equity market economically and statistically significant role of market risk for the determination of expected returns. Instead of identifying more risk factors, a detailed analysis of a single risk factor is undertaken. We have concentrated on two main extensions of the standard CAPM model. First, the standard model is extended by taking higher moments into account. Second, the risk factors are allowed to vary over time in the autoregressive process. The result of unconditional non-linear generalisation of the standard model reveals that in the higher-moment CAPM model the investors are rewarded for co-skewness risk. However, the test provides marginal support for rewards of the co-kurtosis risk. Finally, the empirical usefulness of conditional higher moments in explaining the cross-section of asset return is investigated. The results indicate that the conditional co-skewness is an important determinant of asset pricing, and the asset pricing relationship varies through time. The conditional covariance and the conditional co-kurtosis explain the asset price relationship in a limited way. It is concluded that Kraus and Litzenberger (1976) attempts to develop a modified form of the Sharpe- Lintner-Black CAPM and is more successful with KSE data.

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Paper provided by Pakistan Institute of Development Economics in its series PIDE-Working Papers with number 2008:49.

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Length: 28 pages
Date of creation: 2008
Date of revision:
Handle: RePEc:pid:wpaper:2008:49
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  1. Bollerslev, Tim & Engle, Robert F & Wooldridge, Jeffrey M, 1988. "A Capital Asset Pricing Model with Time-Varying Covariances," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 116-31, February.
  2. 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 607-36, May-June.
  3. Hansen, B.E., 1992. "Autoregressive Conditional Density Estimation," RCER Working Papers 322, University of Rochester - Center for Economic Research (RCER).
  4. Harvey, Campbell R. & Siddique, Akhtar, 1999. "Autoregressive Conditional Skewness," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 34(04), pages 465-487, December.
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  7. Robert F. Dittmar, 2002. "Nonlinear Pricing Kernels, Kurtosis Preference, and Evidence from the Cross Section of Equity Returns," Journal of Finance, American Finance Association, vol. 57(1), pages 369-403, 02.
  8. Shanken, Jay, 1992. "On the Estimation of Beta-Pricing Models," Review of Financial Studies, Society for Financial Studies, vol. 5(1), pages 1-33.
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  11. Harvey, Campbell R., 1989. "Time-varying conditional covariances in tests of asset pricing models," Journal of Financial Economics, Elsevier, vol. 24(2), pages 289-317.
  12. Scott, Robert C & Horvath, Philip A, 1980. " On the Direction of Preference for Moments of Higher Order Than the Variance," Journal of Finance, American Finance Association, vol. 35(4), pages 915-19, September.
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  15. Fang, Hsing & Lai, Tsong-Yue, 1997. "Co-Kurtosis and Capital Asset Pricing," The Financial Review, Eastern Finance Association, vol. 32(2), pages 293-307, May.
  16. Gibbons, Michael R & Ross, Stephen A & Shanken, Jay, 1989. "A Test of the Efficiency of a Given Portfolio," Econometrica, Econometric Society, vol. 57(5), pages 1121-52, September.
  17. Lim, Kian-Guan, 1989. "A New Test of the Three-Moment Capital Asset Pricing Model," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(02), pages 205-216, June.
  18. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. " Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March.
  19. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
  20. Ingersoll, Jonathan, 1975. "Multidimensional Security Pricing," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 10(05), pages 785-798, December.
  21. Arditti, Fred D. & Levy, Haim, 1972. "Distribution Moments and Equilibrium: A Comment," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 7(01), pages 1429-1433, January.
  22. Sears, R Stephen & Wei, K C John, 1985. " Asset Pricing, Higher Moments, and the Market Risk Premium: A Note," Journal of Finance, American Finance Association, vol. 40(4), pages 1251-53, September.
  23. Wayne E. Ferson & Campbell R. Harvey, 1999. "Economic, Financial, and Fundamental Global Risk In and Out of the EMU," NBER Working Papers 6967, National Bureau of Economic Research, Inc.
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