Testing the Applicability of the CAPM Model in the Case of BSE 500 Stocks

Vinayak Arun Sahi

Class: SY-A Roll: A-053

Sarla Anil Modi School of Economics

Financial Economics

Dr. Suranjana Joarder

Introduction

The Capital Asset Pricing Model (CAPM) examines the association between
systematic risk and expected return of a stock. The greater the systematic risk, greater the
expected return on a stock. The aim of the CAPM is to check if an asset is priced fairly,
considering its risk and other factors.

It demonstrates that the E(r) on a stock is the risk-free rate of return plus a risk
premium. This premium depends on the stock’s beta. The formula for expected return is
given below:

𝐸(r)=𝑅𝑓+𝛽(𝑅𝑚−𝑅𝑓)

Where: E(r) – Expected Return

Rf – Return on risk-free asset

Rm – Return on Market Portfolio

The CAPM has several limitations owing to its numerous assumptions which make it
difficult to apply in real-life scenarios. However, it is still used widely due to the easy
comparison it facilitates between different investment alternatives.

Sectors Selected

This paper is aimed at testing the CAPM for 15 BSE 500 stocks, taking the returns on
stocks of three companies from five sectors each. The sectors chosen are listed below, along
with the companies selected within the sectors.

1. Airlines -
a) Jet Airways India Ltd.
b) SpiceJet Ltd.
c) Global Vectra Helicorp Ltd.
2. Telecomm Service Providers -
a) Bharti Airtel Ltd.
b) Vodafone Idea Ltd.
c) MTNL
 3. Diamond and Jewellery –
a) PC Jeweller Ltd.
b) Titan Company Ltd.
c) Asian Star Company Ltd.
4. Hospitals and Healthcare Services -
a) Apollo Hospitals Enterprise Ltd.
b) Fortis Healthcare Ltd.
c) Kovai Medical Center and Hospital Ltd.
5. Electric Equipment –
a) Havells India Ltd.
b) ABB India Ltd.
c) Siemens Ltd.

Data

The analysis has been carried out for the calendar years 2015-2020. Data on the
weekly adjusted closing prices of 15 stocks were taken from online databases for calculating
returns. The market index used is BSE 500 and all the company stocks have also been
selected from those listed on the Bombay Stock Exchange. The risk-free rate of return has
been taken as the yield on 91-Day Treasury Bills from the EPW database.

Daily data is subject to high fluctuations whereas monthly data gets smoothed out
over the course of the 30 days. Therefore, weekly data is the best choice.

Methodology & Analysis

Weekly adjusted closing prices for the stocks have been used to calculate % returns.
The same has been done for the BSE 500 index. These returns have been used to calculate the
CAPM beta (β) and alpha (α) from the slope and intercept coefficients obtained from a
regression analysis of the excess returns of the market index and individual company stock
over the risk-free rate. A regression analysis is also performed to reject/accept the null
hypothesis (intercept is 0).
The weekly returns have then been annualized by utilizing the annualization formula
𝐴𝑛𝑛𝑢𝑎𝑙 𝑅𝑒𝑡𝑢𝑟𝑛=((1+𝑖) ^52−1)
Where ‘i’ is the average of all the weekly returns during the particular time period.
 For the CAPM to hold – α must be equal to 0, the expected returns must be equal to
the actual return on a company’s stock.

In the case of all 15 stocks, it was found that the value of the intercept - α – was not 0.
Moreover, the p-value obtained for the intercept in each case was less than 0.05, implying
significance. This implied that there was enough evidence to reject the null-hypothesis.

Conclusion

We can conclude that the CAPM model is not applicable in the case of BSE 500
stocks.
References

Basu, D., & Chawla, D. (2010). An Empirical Test of CAPM—The Case of Indian Stock
Market. Global Business Review, 11(2), 209-220. doi:10.1177/097215091001100206

Economic and political weekly. (2015, June 05). Retrieved March 21, 2021, from
https://www.epw.in/

Yahoo finance - stock Market Live, Quotes, business & finance news. (n.d.). Retrieved
March 21, 2021, from https://finance.yahoo.com/