CAPM is the most widely used model for estimating the cost of equity. However, CAPM only prices systematic risk, and is this really appropriate in markets where investors are often poorly diversified. Also,neither thin trading estimates of beta and the return on the markets are likely to be very unreliable.
The CAPM is a 'classical' asset pricing model. I employed the 'non-classical' liquidity-adjusted version of CAPM, i.e. the LCAPM, for the Polish emerging stock market. The LCAPM was introduced by Acharya and Pedersen (2005). Their model helps to explain how asset proces are affected by illiquidity risk and commonality in liquidity. The LCAPM takes into consideration various sources of illiquidity risk. In contrast to previous studies for the U.S. stock market, my empirical results reveal no reason to reject the hypothesis that illiquidity risk is not priced in the Polish market.
Acharya, Pedersen (2005) Asset pricing with liqiudity risk, Journal of Financial Economics, 77(2), pp. 375-410.
The CAPM is a robust theoretical model, but empirically has been questioned. The literature on the CAPM is very wide, and equally wide is the empirical literature that questions the CAPM (eg Fama & French). I believe that the multi-factor models are more explanatory. I attach my paper on the Three-factor model, I hope will be helpful.
CAMP ASSUMPTIONS: Model works with the following assumptions: (i) the agent maximizes economic utility; (ii) investors are rational and risk averse; (iii) there is a diversified range of investment; (iv) investors cannot influence price; (v) investor can lend and borrow at risk free rate, i.e. government bond rate; (vi) trade without transaction cost or taxation cost; (vii) securities are highly divisible; (viii) homogeneous expectation among investors; and ix) the same information is available to all investors int he market. Almost none of these conditions exists in frontier economies.
FRONTIER ECONOMY: Frontier economies or markets are irregular markets which are usually small or underdeveloped. it could be classified into three basic groups: (a) small market but highly developed; (b) countries with investment restrictions and had been recently open to outside investors; and (iii) countries with lower level of development, i.e. Myanmar or Vietnam, in comparison to emerging market, such as India or China. Investors in frontier economies are normally risk affine, but under CAPM investor is risk averse.
ALTERNATIVE MODELS: there does not appear to be a formal model for this type of market. People int he field seem to construct indices of market performance to assess frontier market. See book by Kamar Jaffer for detailed discussions on frontier economies.
- Badges
- Science topic
- Similar topics
- Psychology
- Mental Processes
- Learning