Page 1 of 12
Journal for Studies in Management and Planning
Available at http://internationaljournalofresearch.org/index.php/JSMaP
e-ISSN: 2395-0463
Volume 01 Issue 02
March 2015
Available online: http://internationaljournalofresearch.org/ P a g e | 293
Comparative Assessment of the Analytical Risk-averse
Premium Model and its Risk and Returns: Critical Analysis of
Capital Asset Pricing Model (CAMP)
S. Husnain Raza Shah1, Abbas Jaffar*2, Muhammad Anwer3, Najabat Ali4
1Research Scholar, Department of Business Administration,
COMSATS Institute of Information Technology (CIIT), PAKISTAN.
*
2PhD Scholar, Glorious Sun School of Business and Management,
Donghua University, West Yan’an Road 1882, Shanghai Post Code 200051 China.
3Faculty Member & Researcher, Special Education Department, Government of Gilgit-Baltistan, PAKISTAN.
4Research Scholar, Hamdard Institute of Education and Social Sciences,
Hamdard University, Main Campus, Karachi, Post Code 75250 - PAKISTAN.
*
2Corresponding Author: Abbas Jaffar Email: abbas.jaffar@hotmail.com
Abstract
This research study attempts to explain the
risk and returns of Capital asset pricing
model in stocks and investments scenario. In
this present study, the model (CAPM) is
validated both theoretically and empirically
subsequently. Capital asset pricing model is
one of the tools for investors to take a
decision regarding their investments in
various situations by offering risk adjusted
returns. This paper creates a concrete
underlying building blocks for an investor
keeping in view the Modern Portfolio Theory
and also the risk and return considerations.
Beta is used to prioritize the understanding
of different available funds in the market,
fund strategies and also to identify
instruments for the investors to diversify
portfolios of investments. Finally readers
would get the idea of how much exactly the
investor would get return in order to put his
investment in a riskier asset management
company instead of a sovereign entity i.e.
bank. This paper provides a general
investment opportunities for investors not
only in order to quantify the risk but also
explaining the best risk adjusted returns into
estimates of equities expected return.
Keywords: Asset Pricing Models, Capital
Asset Pricing Model, Linear Function
Relationship, Risk and Return.
Introduction
Capital Asset Pricing Model (CAMP)
defines the appropriate theoretical approach
which is obligatory for calculating risk
adjusted rate of return for an asset provided
that the asset is the asset is added to well- diversified portfolio. The attempt of this
paper is to contribute to the literature by
explaining the relationship of capital asset
Page 2 of 12
Journal for Studies in Management and Planning
Available at http://internationaljournalofresearch.org/index.php/JSMaP
e-ISSN: 2395-0463
Volume 01 Issue 02
March 2015
Available online: http://internationaljournalofresearch.org/ P a g e | 294
pricing model with the market risk and return.
Specifically, this paper constructs a series of
relationships between individual and market
risk/return behaviors and also tries to
compare it empirically. Generally the
investors are risk averse. Capital asset
pricing model states the relationship between
risk and the expected return. Empirically
capital asset pricing model is tested by
(Black 1972), (Douglas 1969), (Miller 1972).
In equilibrium the expected return on an
investment is equal to the Risk-free Rate plus
a premium for market risk. It characterizes
the financial markets in total, in order words
the entire demand side and the entire supply
side is captured by the capital asset pricing
model. An investor would receive return
against the placement of capital in some
security either risky or a security which has
0% risk. An investor has a choice to put the
money in either a bank(term deposit), the
bank is guaranteed by the government and
the investor has the opportunity to earn 3
percent with 0 risk, also an investor has a
choice to put the capital in some asset
management company with medium risk
which is also called the systematic risk, this
investment allows investor to get 3 percent
interest, also there is medium risk in this
investment, the investor would go for
investing the capital in a bank(term deposit)
because there investor would receive exactly
the same expected return as the asset
management company, so why to take an
extra risk, but if an investor put his money in
a fund with a medium risk, investor would
get 4 percent extra return, so it becomes 7
percent, the investor would get extra 4
percent of bearing the risk, this 4 percent
extra is called a risk premium, this is sort of
prize, the prize which an investor get in order
to bear more risk against his investment, this
investment has equal importance because it
offers an investment with extra 4% in order
to place capital in a security which has
medium risk. There is third investment
option, this investment has higher risk, the
question arises what will be the profit this
third company offered to the investor to
convince investor to invest his capital in this
high risky investment?
This has to be answered by the capital asset
pricing model the profit for this investment is
called the cost of equity denoted by Hr, this is
the amount of money which an investor
would receive in order to put his capital in
more risky security. The model is shown in
figure 1.
Page 3 of 12
Journal for Studies in Management and Planning
Available at http://internationaljournalofresearch.org/index.php/JSMaP
e-ISSN: 2395-0463
Volume 01 Issue 02
March 2015
Available online: http://internationaljournalofresearch.org/ P a g e | 295
This model is used in two ways either you are
an investor or you are another person asking
for investment to some other person (agent),
if you put your investment in more risky
security then you should take more profit
from the company for bearing this extra risk,
if you want to find out exactly how much
extra profit you will get in order to put your
capital in more risky security, you need to
understand capital asset pricing model.
Classically in the expected rate of return of
an asset and the market portfolios expected
return there establishes a linear relationship.
And the linear relationship’s slope is called
as a beta and defined as covariance of the
asset’s ration and portfolios rates(market) to
the variance of the rate(market) (Michael
Zabarankin 2013a). If the beta of the asset
and the portfolio of the market’s expected
rate is given the capital asset pricing models
prediction is about the assets expected rate of
return. Therefore, the beta of an asset is
defined in a different manner. Ideally its
much linked with a deviation measure and a
risk which is used in the selection of a
portfolio which yields a portfolio which is
optimal. At the time of the invention of the
capital asset pricing model by (Sharpe. 1964)
and (Lintner 1965) a lot of work has been
done later on in this field which testifies
capital asset pricing model (Fama 1973)
(Schwert 1990). The drawbacks which are
found in the traditional Capital asset pricing
model and later on (Solnik 1982) with his
effects developed the International Arbitrage
Pricing Theory. (Campbell 1987) draws out
how will be the capital asset pricing model
specification should be conditional, allowing
for returns to vary over time. After many
