A Study on Capital Asset Pricing Model with Different Approaches to Risk in Tehran Stock Exchange

In any market, knowing the best method of measuring risk can be very useful for investors and policymakers. In this regard, twenty of best seller corporations of Tehran Stock Exchange (TSE) were studied using monthly historical data (from April 2004 to March 2011). Several variations of the capital asset pricing model (CAPM), such as Lower Partial Moment-Capital Asset Pricing Model (LPM-CAPM), Asymmetric Response Model (ARM), and traditional CAPM were empirically tested. The results show that the traditional Capital Asset Pricing Model is the best model at the present period.
Theoretical Framework: A plethora of empirical tests of the CAPM that implicitly assume the mean-variance based preference of the investors have been performed. However, statistical tractability of mean-variance analysis based on multivariate normality is a more important consideration in the development of the theory than the explicit recognition of investor preferences. Beginning from about the last quarter of the twentieth century, alternative theories based on different perceptions of systematic risk have challenged the dominance of the mean-variance notion of risk-return relationship. The most prominent of these is the asset pricing theory which recognizes risk as the deviation below a target rate of return. Downside risk measures and the associated asset pricing models are motivated by economic and statistical considerations; investor psychology is consistent with asymmetric treatment of the variations in the returns and empirical return distributions appear to be non-normal. Bawa and Lindenberg (1977) developed an asset pricing model, which we refer to as the mean-lower partial moment (MLPM) model, based on downside risk. In the MLPM model, risk is defined as the deviation below the risk-free rate. For normal and student-t-distributions of returns, the MLPM model reduces to the conventional CAPM. In the MLPM model, the downside beta simply replaces the CAPM beta. Bawa and Lindenberg (1977) argue that their model explains the data at least as well as the CAPM does. Harlow and Rao (1989) developed an asset pricing model in the downside framework that is more general in that the risk is defined as the deviation below an arbitrary target rate.
Twenty of best seller corporations of Tehran Stock Exchange (TSE) were studied using monthly historical data (from April 2004 to March 2011). Several variations of the capital asset pricing model (CAPM), such as Lower Partial Moment-Capital Asset Pricing Model (LPM-CAPM), Asymmetric Response Model (ARM) and traditional CAPM, were empirically tested.
The results show that, traditional Capital Asset Pricing Model, is better than Lower Partial Moment-Capital Asset Pricing Model (LPM-CAPM) and Asymmetric Response Model (ARM) in our selected period (from April 2004 to March 2011).
Conclusions and Suggestions: The results show that despite some empirical tests in recent years, it seems that by using long samples, traditional CAPM model could be a reliable test. Finally, authors suggest that to achieve more reliable results in CAPM models, researchers have to consider environmental conditions to use the best model.