An Analysis of the Relationship between Risk and Expected Return in the BRVM Stock Exchange: Test of the CAPM

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1 esearch n World Economy Vol. 5, No. 1; 2014 An Analyss of the elatonshp between sk and Expected eturn n the BVM Stock Exchange: Test of the CAPM Kolan Pamane 1 & Anan Ekoue Vkposs 2 1 School of Management, Wuhan Unversty of Technology, Wuhan, Chna 2 Swakop Uranum (Proprety) Ltd, Olympa Wndhoek, Namba Correspondence: Kolan Pamane, School of Management, Wuhan Unversty of Technology, Wuhan , Chna. E-mal: kolastudent2@yahoo.fr eceved: October 22, 2010 Accepted: November 10, 2010 Onlne Publshed: March 1, 2014 do: /rwe.v5n1p13 UL: Abstract One of the most mportant concepts n nvestment theory s the relatonshp between rsk and return. Ths relatonshp drves the theoretcal foundaton of many nvestment models such as the well known Captal Asset Prcng Model whch predcts that the expected return on an asset above the rsk-free rate s lnearly related to the non-dversfable rsk measured by ts beta. Ths study examnes the Captal Asset Prcng Model (CAPM) and test t valdty for the WAEMU space stock market called BVM (BOUSE EGIONALE DES VALEUS MOBILIEES) usng monthly stock returns from 17 companes lsted on the stock exchange for the perod of January 2000 to December Combnng Black, Jensen and Scholes wth Fama and Macbeth methods of testng the CAPM, the whole perod was dvded nto four sub-perods and stock s betas used nstead of portfolo s betas due to the small sze of the sample. The CAPM s predcton for the ntercept s that t should equal zero and the slope should equal the excess returns on the market portfolo. The results of the study refute the above hypothess about the slope and offer evdence aganst the CAPM for all the sub-perod and even for the whole perod. The tests conducted to examne the nonlnearty of the relatonshp between return and betas support the hypothess that the expected return-beta relatonshp s lnear. Addtonally, ths paper nvestgates whether the CAPM adequately captures all-mportant determnants of returns ncludng the resdual varance of stocks.the results demonstrate that resdual rsk has no effect on the expected returns of stocks for the whole perod and the entre sub perods except for the last perod of whch shows that returns are affected by non-systematc rsks durng that specfc perod, justfyng the fact that the operatng actvtes of the frms have an mpact on ther stocks returns Keywords: CAPM, beta, BVM stock exchange, rsk, expected return 1. Introducton The nature and performance of fnancal systems n developng countres must be judged n relaton to an ndvdual country's level of development. Whether these fnancal systems are relatvely smple or hghly complex the prmary role of the fnancal system n any economy s to moblze resources for productve nvestment. The fnancal system provdes the prncpal reasons to transfer funds or savngs from ndvduals and companes to prvate enterprses, farmers, ndvduals, and others n need of captal for productve nvestment. An effcent fnancal system channels resources to actvtes that wll provde the hghest rate of return for the use of the funds. These resources stmulate economc growth; provde enterprses wth the ablty to produce more goods and servces and generate jobs. Well performed and formal fnancal market offer to nvestors a varety of short and long term nvestment nstruments by provdng qualfed fnancal ntermedares that enable ndvduals to make reasonable and adequate decsons about the rsks and rewards of nvestng ther funds. These nstruments package rsk and returns effectvely so that the nvestors who wsh to partcpate n a well structured and approprate market can do so. Fnancal rsks are a relatvely recent phenomenon, evolutonary speakng. The chance that an nvestment's actual return wll be dfferent than expected return ncludes the possblty of losng some or all of the orgnal nvestment. Most lterature on ths subject defnes the term rsk as comprsng two elements: Frst s the probablty (or lkelhood) of occurrence of a negatve event durng the lfetme of operaton of a faclty: Second s the resultant consequence when a negatve event has taken place (ackwtz 2001, Bedca 2000, eccha 2002). Publshed by Scedu Press 13 ISSN E-ISSN X

2 esearch n World Economy Vol. 5, No. 1; 2014 Despte the fact that many studes have been made regardng the fnancal markets of developed countres lke the Unted States, very few have been conducted n the case of emergng economes and especally n the area of the WAEMU space. In ths sense very few are the studes that focus on the analyss of fnancal rsk of captal markets n West Afrca and partcularly at BVM. Most studes on the BVM captal market are lmted to the analyss of market structure and the evoluton of dfferent ndex. Many studes also revealed the nsttutonal weaknesses and the fnancal problems facng the BVM and some approaches of solutons were proposed, but the relatonshp between rsk and returns or more precsely the test of the rsk-return relatonshp on ths market are very few. In ths order our study s devoted to revew the man rsks facng the BVM and analyze the correlaton and the nter-dependency between rsk and expected return of the dfferent market players. 2. The Emprcal Apprasal of the CAPM ecently the fnance dscplne has developed much theory about the rsk measurement and ts use n assessng returns. The two major components of ths theory are beta β, takes as a measure of rsk, and the CAPM, whch uses beta to estmate return. The CAPM s mportant because t was the frst equlbrum asset prcng model that hnges on mean-varance portfolo selecton under uncertanty. It provdes the relatonshp between and nvestment s systematc rsk and ts expected return. Therefore, gven the general rsk-averson of the market, nvestments wth hgh levels of systematc rsk can be expected to produce a hgh return, and vce versa. The model s bult upon a number of assumptons, some of whch are realstc, others of whch are not. These assumptons may be dvded nto two groups about nvestors and captal markets. Wth beta, as the measure of non-dversfable rsk of an asset relatve to that of the market portfolo, the CAPM defnes the requred return on an nvestment as follows: Where β s the measure of rsk for asset. E r E The CAPM can be dvded nto two parts: The rsk-free rate of return, and the rsk premum, E f rsk premum s the amount of return nvestors demand beyond the rsk-free rate to compensate for the nvestment s non-dversfable rsk as measured by beta. To fnd the beta, measure of the systematc rsk, we wrte: Cov Var Publshed by Scedu Press 14 ISSN E-ISSN X M r, M M M MM Accordng to the captal asset prcng model, the equaton (2) can be rewrtten to express that the rsk premum on ndvdual asset equals ts beta tme the market rsk premum: E r E f The usual estmator for β s the OLS estmate from the followng lnear regresson, called the characterstc lne. Where t s the error term and r t a constant t ft t M f r f r Mt ft t 3. The WAEMU Space: An Overvew The West Afrcan Economc and Monetary Unon (WAEMU) was establshed by the Unon Treaty sgned at Dakar on January 10, 1994 by the Heads of State and Government of seven countres n West Afrca whch have n common the use of the CFA currency. The Treaty was effectve from the 1st August 1994, after ratfcaton by Member States. On May 02, 1997, Gunea-Bssau became the 8th Member State of the Unon. 3.1 The WAEMU Captal Market The West Afrcan Economc and Monetary Unon (WAEMU) fnancal system conssts of a relatvely new regonal stock market, a bankng sector and a mesh of mcrofnance nsttutons, known as Decentralzed Fnancal Structures (DFS). Despte ther relatve performance, decentralzed fnancal structures have encountered varous development requrements, partcularly ther ncluson n the fnancal system and sustanablty n a long-term perspectve. The M r f.the

3 esearch n World Economy Vol. 5, No. 1; 2014 fnancal market s known as the BVM (Bourse egonal des Valeurs Moblères) and has two value weghted ndexes that nclude all the lsted frms and the top 10 frms on the market. The egonal Stock Exchange (BVM), the stock market for the UEMOA regon, started operatng n September It s located n Abdjan and has a branch n each captal cty of the other member States of the Unon. Its man role s to pool and process stock market orders transmtted by brokerage companes (Socété de Geston ett d Intermédaton- SGI) authorzed to negotate securtes quoted on the BVM. As of December 2006, 19 SGIs were regstered n the Unon wth nne located n Côte d Ivore. The BVM s regulated by the CEPMF whose responsbltes nclude the promulgaton of polces and procedures to regulate the BVM, and the promoton of a regonal bond market. In order to lst on the BVM, all bond ssues must be guaranteed by an approved fnancal nsttuton, a development fnancal nsttuton, a guarantee fund, or the Parent Company. At the end of December 2006, the captalzaton of the equty market was XOF 2067 bn whereas the bond market captalzaton stood at XOF 489 bn, wth XOF 260 bn beng government bonds, representng 1.07% of the GDP of the Unon. By end-december 2006, 61 securtes weree lsted, ncludng 40 shares and 21 bonds, compared to 57 securtes comprsng 39 shares and 18 bonds by end-december Out of the 40 companes that are lsted on the Exchange n December 2006,, all but four were Ivoran nsttutons. The BVM s equpped wth a fully ntegrated and modern system of tradng. The headquarters n Abdjan provdes securtes quotaton and tradng servcess as well as regulaton/ssungg servces. On Fgure 1, we can apprecate the evoluton of the BVM ndexes known as BVM Composte and BVM 100, from 2000 to 2008 n FCFA. 250 Evoluton of BVM Indexess from December 2000 to Index prces BVM 10 0 years Fgure 1. Evoluton of the BVM ndexes from 2000 to 2008 From the year 2000, we can notce a well ncrement of both the BVM 10 and d BVM Composte ndexes. From respectvely and n 2000, they reached ther hgher level n 2007 wth for the BVM 10 and for BVM Composte, before declnng n Today, the benchmark ndex, the BVM Composte Index, tumbledd 0.90% to Ths was underlned by losses n SLBC (7.50% to CFA ), SMBC (6.60% to CFA ) and UNLC (4.61% to CFA ). Others were NTLC, SOBC, SPHC and FTSC. Meanwhle, CIEC and SIVC advanced by CFA 5 each to CFA and CFA respectvely. Takng nto account the Market per sector, we can notce that n 2005 the Servce Publcs sector had performed very well compare to the other sectors. Ths mprovement was due to thee good performance of SONATEL wth a total of shares exchanged and ts meteorc rse over FCFA.. From 2005 to 2007, the market tendency move drastcally wth only 3.43 % for the Servce Publcs and 81.87% for the Fnance sector. The sector of fnance Publshed by Scedu Press 15 ISSN E-ISSN X

4 esearch n World Economy Vol. 5, No. 1; 2014 remans the most dynamc sector wth shares traded, representng 81.87% of the total volume of the annual market transactons. Ths volume s due to the hgh actvty of ETIT (Ecobank) whchh totalze shares traded, or 97.71% %. The Fnancal sector contnues ts growth n year It totalze the most mportant traded volume of the market wth sharess traded, representng 92.01% of the annual transactons n the market. The sector has been drven by the ntense actvty of ETIT (Ecobank) wth shares traded. Fgure 2 shows the man characterstcs of the market captalzaton per sector. Market Captalza ton per Sector n August 2005( %) Agrculture, 4.76% Transportaton, 1.78% Other Sectors, 0.07% Fnance, 11.5% Industry, 21.59% Dstrbuton, 5.48% Servce Publcs, 54.81% Market Captalzaton per Sector n 2007 (n %) Agrculture, 13.28% Transportaton, 0.08% Other Sectors,, 0% Industry, 1.16% Servce Publcs, 3.43% Dstrbuton, 0.17% Fnance, 81.87% Publshed by Scedu Press 16 ISSN E-ISSN X

5 esearch n World Economy Vol. 5, No. 1; 2014 Market Captalzaton per Sector n 2008 ( n %) Industry, 0.42% Transportaton, 0.06% Other Sectors, 0.01% Servce Publcs, 1.08% Agrculture, 4.92% Dstrbuton, 0.88% Fnance, % Source: evue trmestrelle, Fgure 2. Market captalzatonn per sector 4. Objectve and Sgnfcance of the Study Because nvestors are rsk averse, they wll choose to hold a portfolo of securtes to take advantage of the benefts of Dversfcaton. Therefore, when they are decdng whether or not to nvest n a partcularr stock, they want to know how the stock wll contrbute to the rsk and expected return of ther portfolos. Our man objectve n ths paper s to nvestgate the relatonshp between the securtes portfolo rsk and the return on nvestment of the selected frms n the regonal stock market of the West Afrcan Economc and Monetary Unon called the BVM and prospect on how ths affects ther nvestment decsons. In other words, our objectve s to test the sk eturn relatonshp on the BVM market usng the CAPM. Many authors have already search about the concept sk eturnn on dfferent fnancal markets, and resultss dffer from one to the other, gong from a postve to a negatve correlaton between the two varables accordng to the model used. But most of these studes have been made n developed countres fnancal markets and only very few take nto account the emergng countres fnancal markets and especally the WAEMU space one. Based on ths remark, t s so mportant to focus and pay attenton on how the concept of sk eturn s vew and measured at the BVM stock exchange and to analyze the dfferent factors nfluencng t. That s why ths study reveal a so great mportance n the area of rsk and return analyss n emergng countres and especally n the WAEMU space. It contrbutes to the latter lterature by examnng the relaton between expected market returns and rsk n the BVM. It uses data on a fronter market and tests for the rsk-returns tradeoff n the BVM for the frst tme usng the tradtonal captal asset prcng model (CAPM) of Sharpe and Lntner. Second, t contrbutes to the lterature on ths mportant relaton by showng thatt the rsk-returns tradeoff n the BVM s conform to those found n mature markets. Thrdly t s showng the mportance of rsk analyss and good securtes portfolo strategy formulaton n the area of fnancal nvestment. Fnally based on the fndngs off ths research, the thess wll provde potental researcherss wth area of future research and study n emergng countres fnancal markets and the West Afrcan Economc and Monetary Unon n partcular 5. Hypothess of the esearch H10 Expected stock return has a postve and statstcally sgnfcantt relatonshp wth sk n the BVM market H11 Expected stock return on the BVM market has a postve butt not statstcally sgnfcant relatonshp wth the measure of systematc rsk Publshed by Scedu Press 17 ISSN E-ISSN X

6 esearch n World Economy Vol. 5, No. 1; 2014 H20 Hgher/lower rsk yeld hgher/lower expected rate of return on BVM stock market H21 The non-systematc rsks has no effect on stock s returns at BVM H30 expected rate of return and stock s beta are lnearly related 6. Theoretcal Evdences about the elatonshp between sk and Expected eturn Many nvestors notce that the stock market s a volatle place to nvest ther money. The perodc moves can be dramatc, but t s ths volatlty that also generates the market returns for nvestors. Volatlty s a measure of dsperson around the mean or average return of a securty. For securtes, the hgher the standard devaton, the greater the dsperson of returns and the hgher the rsk assocated wth the nvestment. Volatlty creates rsk that s assocated wth the degree of dsperson of returns around the average. In other words, the greater the chance of lower-than expected return, the rsker the nvestment. There s a strong relatonshp between volatlty and market performance. Volatlty tends to declne as the stock market rses and ncrease as the stock market falls. When volatlty ncreases, rsk ncreases and returns decrease. sk s represented by the dsperson of returns around mean. The greater the dsperson of returns around the mean, the larger wll be the drop n the compound return. (The rate of return, usually expressed as a percentage, whch represents the cumulatve effect that a seres of gans or losses have on an orgnal amount of captal over a perod of tme. Compound returns are usually expressed n annual terms, meanng that the percentage number that s reported represents the annualzed rate at whch captal has compounded over tme). The work of Markowtz (1952), whch developed the basc portfolo theory, descrbed a lnear relatonshp between rsk and return, and proved to be useful for portfolo and asset management. Snce hs work, many other researchers concentrate ther work on nvestgatng the relatonshp between stock returns and volatlty for developed markets. Uncoverng the relatonshp between rsk and return provdes a better understandng of prce dynamcs and can serve as a gude for buldng new asset prcng models. Usng Pettengll et al. s approach, Hodoshma, J. X. Garza-Gomez and M. Kunmura (2000) examned beta-return relatonshps n Japanese market, by ncludng sze, and book to market equty rato as control varables nto ther model. The study perod goes from the perod 1956 to 1995, and ncluded all the stocks lsted n the frst secton of Tokyo Stock Exchange (TSE). The collateralzed next day call money rate was used as rsk-free rate. As a proxy to the market they used both JSI (Japanese Securtes esearch Insttute), and EWI (Equally Weghted Index) ndces. 20 portfolos formed by takng nto account the rankng of the betas were used n regresson analyses. They found that data are better explaned by makng a dstncton between postve and negatve market rsk premums. It was also found that the company sze s sgnfcant wth a negatve coeffcent n the uncondtonal CAPM test and wth a postve coeffcent n condtonal test. As we menton before n our prevous secton, the concept of the rsk- return relatonshp has been argue and study n the emergng countres by many researchers, and ther fndngs are qute smlar to those from the developed countres wth some few dfferences related to the characterstcs of the fnancal markets and the soco-economcal envronment of the countres. Many studes have shown that emergng markets are vastly dfferent from those of developed markets n terms of rsk, return, and lqudty patterns. Workng on an emergng stock market, Salman (2002) provdes emprcal evdence to support the postve and lnear relatonshp between rsk and return. Whle studyng the Istanbul Stock Exchange, he fnds that the CAPM s concept s vald and he beleves that both rsk and return are ntegrated n the nformaton provded to the market. Smlarly, a postve and sgnfcant assocaton between rsk and return n the Jordanan Securtes Market was found by Omet, Khasawneh and Khasawneh (2002). In the same logc Koutmos, Negaks and Theodossou (1993) also report a smlar fndng from the Athens Stock Exchange. They fnd that the rsk premum s postve and sgnfcant whch means that the returns are postvely related to volatlty. In a study across eght dfferent ndustres n Tawan, Chang and Doong (1999) dscover that the nfluence of condtonal volatlty on stock returns s mxed dependng on the ndustry. Nonetheless, only the coeffcents wth negatve sgns are found to be sgnfcant. Therefore, the negatve rsk premum suggests that nvestors are penalzed, not rewarded, for holdng rsky stocks. Most of the researches on stock returns n emergng markets ndcate that they are characterzed by hgh rsk and hgh returns. It also show that they are not really ntegrated to the developed markets of the World as evdenced by very low correlaton wth the rest of the World and among themselves (Bekaert and Harvey, 1997). Investor nterest n emergng markets exploded durng the last decade as a result of the quest for hgher returns and further nternatonal dversfcaton. Yet lttle s known about the nature of stock returns n those markets. Publshed by Scedu Press 18 ISSN E-ISSN X

7 esearch n World Economy Vol. 5, No. 1; 2014 It s not surprsng that no study about the rsk-return relatonshp s related to the stock exchange market of the WAEMU space because of ts relatvely recent start pont of operaton. Ths leads N dr. Konan Léon to nvestgate on the relatonshp between expected stock market returns and volatlty n the regonal stock market of the West Afrcan Economc and Monetary Unon called the BVM. Usng weekly returns over the perod 4 January 1999 to 29 July 2005 and the EGACH-n-Mean model, assumng normally dstrbuted and Student's t dstrbuton for error terms, he found that n ths market, the expected stock return has a postve but not statstcally sgnfcant relatonshp wth expected volatlty and argue that ths volatlty s hgher durng the market booms than when market declnes. 7. Emprcal Analyss of the elatonshp between sk and Expected eturn at BVM As we menton before, few studes have been conducted based on the rsk-return relatonshp n the WAEMU space. Those that exst have proved an exstence of rsks n the market and the postve relaton between these rsks and the return of the market, usng the EGACH-n-Mean model. In ths chapter we wll descrbe the sample data used n ths study, and how these data was compled and organzed. Then we wll take a look of the research hypothess and questons. Fnally the research methodology wll be descrbed together wth the justfcaton of the emprcal model used. 7.1 Database Constructon Source of Data and Sample Perod Frms n our sample nclude fnancal nsttutons, banks, nsurance companes, Servce Publcs, Agrculture, Industry, dstrbuton and other sectors frms. A sample of about 40 frms s selected from the above mentoned ndustres and ther nvestment actvtes studed over the perod 2000 to The frms wll be selected from the BVM stock exchange lsted companes and ncluded n the two ndexes of the market: the BVM 10 and the BVM Composte. Data are selected from the statstcal documents for the study perod provded by the frms and the stock markets statstcs data derved from the annual report publcaton of publc shareholdng companes held by the BVM. All ths data are avalable n the Offcal Newsletter publcaton (BOC) of BVM. These newsletters nclude data for all lsted companes comprsed n seven economc sectors as mentoned n the prevous chapter. The study perod from 2000 to 2008, whch s equal to 9 years of accurate data, s adequate for ths study. The analyss s based on annual data Data of the Study The data set used n ths study s monthly closng prces on the BVM composte ndex and the ndvduals stocks closng prces obtaned from the Offcal Newsletter of the egonal Stock Market (BVM). The study perod ranges from end 2000 to end of The choce of the BVM Composte s motvated by the fact that t s composed of all the lsted companes, by ths way we can have an overlook of the whole market performance and rsk trend as well as the well performed frm s one Specfcaton of the Database Wth the avalable monthly reports and Offcal newsletters publcatons, the database was constructed ncludng all fnancal fgures for all the companes lsted at BVM. Lke we dentfy n the prevous chapter, the sample consst of 34 companes of whch 13 are ndustral, 4 agrcultural frms, 4 dstrbuton companes, 7 fnancal companes, 3publc utltes, 2 transportaton frms and 1 for other sectors. The analyss of the rsk-return relatonshp took nto account the frms lsted on the BVM stock exchange market for the perod 2000 to 2008 based on the crtera that, the frm had to be lsted on the market for the whole perod under consderaton and ther share prces avalable for every month n a specfc year. Based on these crtera, 17 frms are selected to buld the portfolo that we use for our analyss. 7.2 The Model of the Study Statstcal Analyss Because samples are small and nformaton s lmted, parametrc model are not approprate we use a non parametrc lnear progresson technque for our study. The method wll be base on a statstcal assessment of rsk n fnancal area. In ths study, the tradtonal approach of the Captal Asset Prcng Model of Fama and MacBeth s wll be use n order to measure the sgnfcance of the market rsks on the frms expected return. The Captal Asset Prcng Model (CAPM) provdes an expresson whch relates the expected return on an asset to ts systematc rsk. Systematc rsk, Publshed by Scedu Press 19 ISSN E-ISSN X

8 esearch n World Economy Vol. 5, No. 1; 2014 whch s also called market rsk or undversfable rsk, s the porton of an asset's rsk that cannot be elmnated va dversfcaton. The systematc rsk ndcates how ncludng a partcular asset n a dversfed portfolo wll contrbute to the rskness of the portfolo. As an economc theory that descrbes the relatonshp between rsk and expected return, and serves as a model for the prcng of rsky securtes, the CAPM asserts that the only rsk that s prced by ratonal nvestors s systematc rsk, because that rsk cannot be elmnated by dversfcaton. The relatonshp between the rsk and the expected return n the CAPM s known as the Securty Market Lne (SML) equaton and the measure of systematc rsk s called Beta The CAPM asserts that: Where s the expected return on securty f s the rsk free rate f M ( M - F) s the market rsk premum And β s the securty s beta The CAPM s a ceters parbus model. It s only vald under a specal set of assumptons lsted below: All the nvestors are rsk averse; they wll maxmze the expected utlty of ther end of perod wealth. Implcaton: The model s a one perod model. All the nvestors use the same expected return and covarance matrx of stock return to form the optmal rsky portfolo. That s referred to as homogenous expectatons (belefs) about asset returns. Implcaton: All the nvestors use the same nformaton at the same tme. A fxed rsk-free rate exsts, and allows the nvestors to borrow or lend unlmted amounts to the same nterest rate. There are a defnte number of stocks and ther quanttes are fxed wthn the one perod world. There are no market mperfectons. Implcaton: there are no taxes, regulatons, or tradng costs. The econometrc specfcaton of CAPM model s the followng: t ft F mt ft t Ths type of model wll be estmated wth ordnary least squares regresson. We assume that the expected value of the error s zero and that t s uncorrelated wth the ndependent varable The Econometrc Model Takng nto account the varables used for our study and all the factors surroundng the choce of those varables, both the Tme seres and the Cross sectonal specfcaton of the CAPM wll be used. The tme seres specfcaton set as follows s used n the frst phase of our analyss. Where t ft : s the rsk premum on th stock n perod t : s the alpha coeffcent or the ntercept mt ft : s the market rsk premum : s the beta of the stock t : s the error term whch s assumed to be random t ft mt ft t Publshed by Scedu Press 20 ISSN E-ISSN X

9 esearch n World Economy Vol. 5, No. 1; 2014 The tme seres specfcaton s used n the frst phase of our analyss to run the regresson between stocks return and the market return n order to determne ther specfc beta coeffcent for each sub perod and for the whole perod of 2000 to The Cross sectonal specfcaton of CAPM s used n the second phase of our study n order to test the rsk- return relaton hypothess at BVM. The model s specfed as follow: f 0 t 1t Where = Equally weghted average return of stocks. = Estmate of true for stock. = Error term whch s assumed to be random 7.3 Data Descrpton Monthly share prces for 17 stocks lsted n the BVM Stock Exchange for the perod 2000 to 2008 are used n ths study. The man consderatons n choosng ths sample s that shares must be contnuously lsted durng the perod defne and shares prces avalable for every month durng a specfc year. End of the month share prces are not adjusted to account for cash and stock dvdends due to unavalablty of data resultng n the underestmaton of stock returns. However ths s not expected to sgnfcantly affect the result of the study. Stock prce returns are calculated usng the formula: t Pt ln P, t 1 Where t = eturn on stock. P t = Prce per share of stock at the end of the month t. P, t-1 = Prce per share of stock at the end of the month t-1. The computaton of the monthly stock market returns mt ˆ mt s as follows: Pmt ln Pm, t 1 Where mt = monthly return on the market. P mt = Value of BVM Composte prce ndex at the end of the month t. P m,t-1 = Value of BVM Composte prce ndex the at the end of the month t-1. ln (.) s the logarthm operator All returns are expressed n local currences and are not adjusted for dvdends. The analyss perod of ths research extends from January 2000 through December Ths perod was dvded nto four 6-year sub-perods. Each sub-perod, n turn, was further dvded nto two 3-year perods beng beta estmaton perods, and the testng perods. The fact s that, because we have a small sample, we use the stocks ndvdual betas n the same portfolo A rather than dvdng the sample nto portfolo. Hence, the portfolo formaton perod and the beta estmaton perod become one, because we don t have to estmate the portfolo beta anymore snce the stocks ndvdual betas are used. All the BVM stocks avalable and meetng data requrements n each perod were ncluded n the analyss. Publshed by Scedu Press 21 ISSN E-ISSN X

10 esearch n World Economy Vol. 5, No. 1; The frst perod s: ; 2. The second perod s: ; 3. The thrd perod s: ; 4. The fourth perod s: In order to avod the beta s measurement bas, we follow Black, Jensen and Scholes (BJS) method by estmatng betas for the last perod and used theses n the groupng of the next perod so that we mtgate statstcal errors from the beta estmaton. Table 1. Beta estmaton for each perod FILTISAC NESTLE SODECI SIVOA SOLIBA SITAB TITUAF SICABLE BICICI BOA BENIN CIE SONATEL SGB CI SHELL CI SOGB SAPH UNILEVE Because the sample of our analyss s small, we only consder one sngle portfolo A of 17 stocks, so nstead of usng a portfolo beta for our analyss, we consder the ndvdual stock s beta ncludes n the portfolo. The frst phase of our analyss conssts of tme seres regresson of 17 companes lsted on BVM Stock Exchange, where stocks return s regressed to the market return n order to determne ther specfc beta coeffcent for each sub -perod. The regresson model used s showed bellow: Where t s the rate of return on asset (or portfolo) at tme t, s the rsk-free rate at tme t, ft mt s the rate of return on the market portfolo at tme t. = estmate of for stock. ( ) t ft mt ft t Publshed by Scedu Press 22 ISSN E-ISSN X

11 esearch n World Economy Vol. 5, No. 1; 2014 t = error term whch s assumed to be random. The coeffcent α s the dfference between the estmated expected return by tme seres average and the expected return as stpulated by the CAPM. If CAPM descrbes expected returns and a correct market portfolo proxy s selected, the regresson ntercepts of all portfolos or assets should be equal to zero. The 17 companes are then set to form one portfolo A whch s the sample of our analyss The next phase nvolves a Fama and Macbeth cross-sectonal regresson (CS) of excess return of the stocks n portfolo A on the estmated betas for each sub- perod usng the regresson model as follows: t f 0 t 1 t t t Valdty of CAPM would be verfed when = 0, and 0. 0t 1t In order to be sure that all the assumptons surroundng the CAPM test hold, we run some specfcs test. To test for nonlnearty between total stocks returns and betas we use the equaton bellow: If the CAPM hypothess hold r 0 1 should be equal to zero e We then examne whether the expected excess return on securtes are determned only by systematc rsk and are ndependent of the nonsystematc rsk, as measured by the resduals varance. The equaton used s set as follows. Where r s the measure of the potental nonlnearty of the return, 3 estmates the explanatory power of non-systemc rsk. 2 e p 2 2 measures the resdual varance of portfolo or stocks return. If the CAPM hypothess s true, γ3 should be equal to zero. We fnally use the t-test In order to statstcally test the CAPM. 8. Emprcal Test and esults 8.1 Emprcal Test for the Perod 1 ( ) Based on the results obtan for the Perod 1, we can estmate that there s a lnear relatonshp between stock s expected returns and ts betas. And that non-systemc rsk has no effect on the returns, ths means that durng the perod, all the stocks returns are explaned only by the systematc or market rsks and all the rsks related to the frms operatons and actvtes does not affect the returns. The CAPM hypothess s, however, rejected takng nto consderaton that estmates of the SML coeffcents do not confrm the CAPM hypothess whch assumes that, hgher/lower rsk yeld hgher/lower rate of return. Accordng to the set hypothess the average rsk premum should be postve, reflectng that nvestors who undertake a hgh rsk should yeld a greater return. Our result shows a negatve sgn for the coeffcent 1, whch mean that for ths perod of tme a hgh rsk doesn t necessarly lead to a hgh return on the BVM market, fact whch s nconsstent wth the CAPM predctons Thus, we conclude that CAPM s not fully vald n perod 1. efer to the Table e e Publshed by Scedu Press 23 ISSN E-ISSN X

12 esearch n World Economy Vol. 5, No. 1; 2014 Table 2. Analyss results for perod 1 coeffcents value t-value P-value Estmaton of SML Test for non- lnearty Test for non-systematc rsks Emprcal Test for the Perod 2 ( ) Takng nto account the results obtan for the Perod 2, we can estmate that there s a lnear relatonshp between stock s expected returns and ts betas. And that non-systemc rsk has no effect on the returns. But the CAPM hypothess s rejected snce the estmates of the SML coeffcents does not confrm the fact that hgher/lower rsk yeld hgher/lower rate of return. The rsk premum for ths second perod s seen to be equal to 0, whch doesn t hold wth the theory whch predcts that the value should be greater than 0. Thus, we conclude that CAPM s not vald for the perod 2. See Table 3. Table 3. Analyss results for perod 2 coeffcents value t-value P-value Estmaton of SML Test for non- lnearty Test for non-systematc rsks Emprcal Test for the Perod 3 ( ) eferrng to the results we obtan for the entre hypothess test durng the thrd perod (shows n Table 6), we can estmate that there s a lnear relatonshp between stock s expected returns and ts betas. And that non-systemc rsk has no effect on the returns, meanng that the stocks returns are only explaned by the market rsks and that no alternatve rsks are affectng the returns. But the CAPM hypothess s rejected snce the estmates of the SML coeffcents does not confrm the fact that hgher/lower rsk yeld hgher/lower rate of returns predcted by the theory. Ths mean that the nvestor who undertake a hgh rsk s not sure to consequently get a greater return. Ths fact s not consstent wth the theory, thus we conclude that CAPM s not vald for the perod 3. efer to Table 4. Publshed by Scedu Press 24 ISSN E-ISSN X

13 esearch n World Economy Vol. 5, No. 1; 2014 Table 4. Analyss results for perod 3 coeffcents value t-value P-value Estmaton of SML Test for non- lnearty Test for non-systematc rsks Emprcal Test for the Perod Based on the above fndngs, especally on the value of 3, t s obvous that the non-systematc rsk has an effect on the stock s returns for ths specfc perod. It means that for ths perod, systematc rsks as well as unsystematc rsks affect the stocks returns on BVM market. Its means that durng ths perod, the frm s stocks returns were affected by other rsks than the market rsk, whch surely comes from the frm s operatng actvtes. But we should notce that beta and the returns are lnearly related to each other supportng the non- lnearty hypothess. the SML hypothess s not confrmed snce the hgh rsk nvestment doesn t procure a hgher return. Thus the CAPM s not vald for ths perod. efer to the Table 5. Table 5. Analyss results for perod 3 coeffcents value t-value P-value Estmaton of SML Test for non- lnearty Test for non-systematc rsks Publshed by Scedu Press 25 ISSN E-ISSN X

14 esearch n World Economy Vol. 5, No. 1; Emprcal Test for the Whole Perod Takng nto consderaton the test of the whole perod from 2000 to 2008, we found that beta-return relatonshp s ndeed lnear wth each other and the systemc rsk s the only factor that affects the rate of return, whch s consstent wth CAPM. However, the fact that hgh/low rsk wll yeld hgh/low return s not sgnfcant durng 2000 to 2008 snce the estmaton of the SML coeffcents shows 1 not dfferent from zero, s nconsstent wth the CAPM. So here we conclude that the CAPM s nvald durng the whole perod. The results are shown n Table 6. Table 6. Analyss results for the whole perod coeffcents value t-value P-value Estmaton of SML Test for non- lnearty Test for non-systematc rsks Concluson and Implcatons Ths study amed to test and examned the valdty of the CAPM for the BVM Stock Exchange. For ths purpose, we used monthly stock returns from 17 companes lsted on the BVM stock exchange over the perod to The companes are selected based on some crtera mentoned n the prevous chapter to ensure the relablty of our result. The purpose of the study has been to examne whether the CAPM s vald on the BVM stock market. By combnng Black, Jensen and Scholes wth Fama and Macbeth methods of testng the CAPM, we got the followngs results summarze n Table 7. Table 7. Summary of the results Perod 1 Perod 2 Perod 3 Perod 4 Whole perod SML eject eject eject eject eject Non-Lnearty Support Support Support Support Support Non-Systematc rsks support support support reject support As mentoned prevously, the valdty of the CAPM requred that all the assumptons and hypothess be verfed. Takng a look of the table 7 and remndng that The CAPM predcton for the ntercept s that t should be equal to zero and the slope of SML equals the average rsk premum, t s obvous that the fndngs of the test contradct the above hypothess and ndcate evdence aganst the CAPM predctons durng each specfc perod and for the whole perod of 2000 to The CAPM hypothess also predcted that the stock expect rate of return has the lnear relatonshp wth ts systematc rsk. The fndngs of the test are consstent wth the above hypothess and ndcate evdence supportng the CAPM predcton for all the sub-perods and durng the perod 2000 to Testng the CAPM hypothess about the non-systematc rsk effect on the stock s returns, the predcton expect that there has no relaton between the returns and the non-systematc rsk at all. The fndngs of the test do not fully contradct the above hypothess, except from the perod 4 where we found evdence that the stocks return s durng that perod are affected by other rsks than the systematc rsks. Ths shows that the operatng actvtes of the frms have an effect on ther stocks returns durng ths perod. But stll, the fndngs of the other sub-perods ndcate evdence supportng the CAPM. Consderng the whole perod, The CAPM predctons that stocks wth hgher/lower rsk wll yeld hgher/lower expect rate of return s not confrmed. However, the beta-return relatonshp s lnear wth each other and the Publshed by Scedu Press 26 ISSN E-ISSN X

15 esearch n World Economy Vol. 5, No. 1; 2014 non-systemc rsk has no effect on the return durng the test perod. Ths fndng s consstent wth the predctons hence the CPAM s not fully nvald. elyng on the above and takng nto consderaton all the mentoned assumptons, we conclude that, our emprcal study do not fully support the CAPM. Thereby, we assume that CAPM do not fully hold true n the BVM Stock Market durng the perod 2000 to Based on all the analyses of the theoretcal approaches and fndngs of our study, ts obvous that several mplcatons can be pont out concernng the valdty of the CAPM n the BVM Stock Exchange. It s clearly shows that, as appled for the most developed countres lke US, Canada and UK, the theoretcal approach of the CAPM can also be appled to an emergng captal market such as BVM and gves strong evdence to support or reject the hypothess. The result obtaned from our analyss mpled controversally to the predctons that nvestors who bear hgher rsk n the BVM stock exchange should not necessarly expect a hgher return from hs nvestment as well as the rsk averse nvestor for whom the probablty to yeld a low return by bearng a low rsk s not certan. The basc logc behnd the captal-asset prcng model s that there s no premum for bearng rsks that can be dversfed away. Thus, to get a hgh average long-run rate of return n a portfolo or for a stock, the nvestor needs to ncrease the rsk level of the portfolo that cannot be dversfed away. But snce our result shows that hgh rsk don t necessarly yeld hgh return; ths logc s no longer applcable n the BVM captal market. Except for the perod four, our fndngs show that the unsystematc rsk has no effect on the stocks returns. Therefore, the fact that the fndng of perod 4 reveal an mpact of non-systematc rsks on the return mpled that nvestors on the BVM market as well as the lsted companes themselves should consder some other factors and varables whch can possbly affect ther return such as the proftablty ratos, the dvdend polcy ratos, the book value etc.. Despte that for most of the perod the non-systematc test confrm the non effect of the unsystematc rsk on returns, the result of perod four suggest that more varables should be take nto account when measurng the rsk-return relatonshp. Our fndngs however are quet consstent wth other studes but s at odd wth the postve and statstcally sgnfcant rsk-return tradeoff prescrbed by fnance theory. 9.1 Lmtaton of the esearch Lke every scentfc work, ths study on the rsk-return tradeoff has some lmtatons. The man lmtatons to be pont out are mostly related to the emprcal study approach n general and partcularly to the data set and the methodology. As recommended by the CAPM, the market portfolo to be used n ths test should combne all the assets n the market. The market for such a portfolo would be the world market. But because t s mpossble to have all the assets worldwde brng nto one portfolo, market ndex s used as a proxy and n our case we choose the BVM Composte. The results of the tests conducted on data do not appear to clearly reject the CAPM. Ths does not mean that the data do not support CAPM. As Black [1972] ponts out these results can be explaned by the fact that measurement and model specfcaton errors arse due to the use of a proxy nstead of the actual market portfolo. Ths error could have based the regresson lne estmated slope towards zero. The results about the CAPM test, to be more accurate should be obtaned based on an nvestgaton about many stocks grouped nto portfolos accordng to ther estmated beta coeffcents as suggest by Black, Jensen and Scholes, and portfolo s beta be used for the test. But due to the fact that the sample of our study s too small, ndvdual stock s betas nstead of portfolo s beta are used for ths study. Ths fact, lke mentoned by some authors could have caused some bases n the estmaton of the coeffcents because by combnng securtes nto portfolos one can dversfy away most of the frm-specfc component of the returns, thereby enhancng the precson of the beta estmates and the expected rate of return of the portfolo securtes. Ths approach can mtgate the statstcal problems that arse from measurement errors n beta estmates. Furthermore, ths small samples and short observaton perod ( ) may also lead to some measurement errors. eferences Asgharan, H., & Hansson, B. (2000). Cross-Sectonal Analyss of Swedsh Stock eturns wth Tme-Varyng Beta: The Swedsh Stock Market European Fnancal Management, 2, Backus, D., & A. W. Gregory. (1993). Theoretcal elatons between sk Premums and Condtonal Varances. Journal of Busness and Economc Statstcs, 11, Balle,. T., & DeGennaro,. P. (1990). Stock eturns and Volatlty. Journal of Fnancal and Quanttatve Analyss, 25, Publshed by Scedu Press 27 ISSN E-ISSN X

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