Does Capital Asset Pricing Model Hold? Evidence from United Kingdom

Abstract

An equilibrium Capital Asset Pricing Model (CAPM) of Treynor (1962), Sharpe (1964), Lintner (1965), Mossin (1966) asserts that stock returns are explained by their betas. Other study by Fama and French (1992) shows that the stock returns can be explained by not only their betas but also their sizes and growth. In this research-based article regressions and hypothesis testing are carried out. With a sample of 50 United Kingdom (UK) stocks, covering the period from 1980-2005, the hypothesis that stock returns are explained only by their betas is rejected. The results from this study also show that stock returns are not related to market returns and there is no linear relationship between actual stock returns and their respective betas. The hypotheses that size and growth have no power to explain the stock returns are also rejected in some cases and accepted in other cases.

Keywords: Capital Asset Pricing Model, CAPM, Beta Validity, Stocks.