Empirical Study of CAPM in China’s Banking Industry

[Abstract] The capital asset pricing model is a one of the most important models in finance when it was first introduced by William Sharpe， John Linter， Jack Treynor and Jan Mossin independently in the early 1960s. The capital asset pricing model is well known as CAPM， which is used in stock market to determine a required market and risk-free asset. （French， C， 2003）. In CAPM， there are several assumptions to simplify the real world in order to allow us to derive a reasonably realistic and comprehensible model. These assumptions include perfect competition assumption， all investors are myopic behave r； investors are limited to a universe of publicly traded te of return of an asset if the asset is going to be added to a well-diversified portfolio， given that asset’s sensitivity to systematic risk ， usually represented by beta（β） in the financial market， together with the expected return of the financial assets such as stocks and bonds and they pay no taxes on return and there is no transaction costs on trades insecurities.

[Keywords] CAPM；banking industy

Literature review

Since CAPM was introduced by Sharpe， Linter and Black， foreign scholars have done a lot of empirical researches in mature capital markets to see the applicability of CAPM， especially in US capital market. In early 1970s， Black， Jensen， Fama and MacBeth used data before 1969 found that CAPM worked as predicted， there was a positive relationship between stocks’ average return and β. Since 1980， however， there became adverse results. Rein-ganum， Lakonishok and Shapiro surprisingly discovered that the relationship between stocks’ average return and β disappeared when using data after 1970. Several classic literature written by Fama and French using data during 1962 and 1989 proved that even in the situation that beta was the only explanatory variable， the connection CAPM predicted was gone.

As we all know， China’s security market started late， CAPM was introduced and put into use since middle 1990s. Earliest researcher Shi Donghui（1996） selected 50 samples in Shanghai Stock Exchange market and the statistics were from 1993 to 1996. The result was that systematic risk did not have a significant linear relation with expected return while non-systematic risk played a more influential role. Many scholars did similar verification of the effectiveness of CAPM in China’s capital market all indicate that it still do not serve Chinese security market well by far.

As this essay mentioned before， CAPM was based on several assumptions， so CAPM can be presented as ： E（Ri） = Rf +β[E（Rm - Rf）]， where β=Cov（Ri， Rm）/Var（Rm）， measures the extent to which returns on the stock and the market move together. High values of beta indicate a riskier asset and low values of beta indicate a more secure asset. E（Ri） represents expected return on individual securities， Rm-Rf means the risk premium of the market portfolio. It is clearly that once CAPM is of applicability in a specific market， it can be used to solve the huge calculate problem when standard portfolio model applied to lager market.

This paper has chosen all the 16 bank stocks in China stock market to analyze whether CAPM works well in China’s banking industry. The reason to pick banking industry is that in China we have relatively stricter regulation on banking sector than others， so share price can more truly reflect the reality of operation in a certain bank. What’s more， banks response to financial information quicker than other fields， unlike medicine or clothing industry， banks are more sensitive to subtle financial message. The data used in this paper is daily merged Chinese securities market data from the day those banks went to public to September 30th， 2013. Several banks went to public very early， take Ping An Bank for example， it listed in 1991 while Agricultural Bank of China went to public only 4 years ago， in 2009， so the data size for each bank range a lot. Daily return rate for every stock， daily risk free return and market average daily return are all included and they were obtained from RESSET Financial Research Database. Table 1 below is the 16 samples’ code and their names.

The table presents all the 16 sample stocks’ code and their names.

Finally， substitute the 16 estimated value of β and ∑εit into the formula in step 3 and the results are following：

conclusion

Above these results from SPSS， we can see that the γ1 is 0.001 and p value of β is 0.591， which means that β is not significant and could not explain the expected return well. More over， when take RSS into this model， RSS become very significant， that is to say， the RSS has a significant impact on the expected return. To conclude， βcould not explain the relationship between the average market return and expected rate of return of these stocks and some other unidentified elements have bigger effect on the expected return.

The CAPM cannot be used to predict assets return in China’s banking industry. These results are not surprise because this model is based on several very strong assumptions about the characteristics of the market. These assumptions maybe not all apply in China. There do exist tax and exchange fees in operation and not all investors are rational mean-variance optimizers， human beings are very complicated and we need to introduce investing psychology to evaluate this complex behavior.

We can conclude that for one hand， China’s capital is still immature compared with America and European countries， although Shanghai Stock Exchange has established since December 1990 and China’s stock market has been developing for 23 years， during these years， China’s stock market adjusted and improved a lot， now become a relatively efficient market but still need a long way to go. On the other hand， we can see that CAPM is not a perfect model， but it provide a correct view to help investors judge whether a certain security overpriced or underpriced， they must pay much more attention in non-systematic risk in China’s capital market. For investment firms， they may take a stand on the validity of the CAPM， if they judge the CAPM invalid， they must turn to a substitute framework to guide them in constructing optimal portfolios.

This paper only test the simplest way of CAPM， there are some extensions of the CAPM need us to make further research. In practice， it is important to relate the true characteristic of the market under analysis with the assumptions of the model， an approach should be given to translate information of the developed market into our real economy.

References：

[1]Banz， Rolf W. The Relationship between Return and Market Value of Common Stock[J]. Journal of Financial Economics， 1981，9：3-18.

[2]Black， Fischer， Michael C Jensen， Myron Scholes. The Capital Asset Pricing Model： Some Empirical Tests[J]. Studies in the Theory of Capital Markets，1972.

[3]Fama，Eugene F， James MacBeth. Risk， Return， and Equilibrium： Empirical Test[J]. Journal of Political Economy， 1973， 81：607-636.

[4]Fama， E.， and French， K.， 2004， The Capital Asset Pricing Model： Theory and Evidence， Journal of Economic Perspectives， 18（3）， pp. 25-46.

[5]French， C， W.， 2003， The Treynor Capital Asset Pricing Model， Journal of Investment Management， 2（1）， pp. 60-72.

[6]Lettau M，Ludvigson S.Resurrecting the（C）CAPM：A Cross-Sectional Test When Risk Premia are Time—Varying[J].Journal of Political Economy，2001，6：1238—1287.

[7]Sharpe，William F. Capital Asset Prices： A Theory of Market Equilibrium under Conditions of Risk[J].Journal of Finance，1964，19：425-442.

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作者簡介：

冷素云 ，1990，女 ， 漢 ， 河南省焦作市博愛縣，單位鄭州大學西亞斯國際學院，職位教師，學位碩士研究生，研究方向 金融學、會計學。