Testing the capital asset pricing model

Abstract

The objective of the study is to validate the claim of the Capital Asset Pricing Model (CAPM). The CAPM claims that there must not be any premium on return for firm specific risk or idiosyncratic risk and expected returns should be determined as per the systematic exposure only. The firm specific risk can be eliminated by holding a diversified portfolio and so no premium must be paid for that. This study focuses on testing this claim of CAPM using the Fama Macbeth procedure. The data for the stocks considered for this study is downloaded from Wharton Research Data Services. It is filtered for the ones that traded on NASDAQ, New York Stock Exchange (NYSE) and American Stock Exchange (Amex) and for the time period between 1966 till 1994. The results show that over this period the market return is not a significant variable in predicting the return of a given stock.