Capital Asset Pricing Model and Evaluation of Fama-Macbeth Regressions - Example

The paper "Capital Asset Pricing Model and Evaluation of Fama-Macbeth Regressions" is a perfect example of a report on finance and accounting. The CAPM model relates the risk and the return of a market based on mathematical estimations to serve as a tool for the investors in predicting the risk associated with any investment. There is a linear relationship between the expected return from the assets and its risk or beta with respect to its market efficient portfolio. Hence the assumption is that a stock that is associated with more risk in comparison to the market is required to compensate the investors for this risk with higher required returns and this factor of market risk is the only factor presumed to be viewed by investors in making investments under the CAPM model.

Fama and French concluded that the high relation between the size and beta hinders the true effect of each variable in justifying the average returns. They indicated that when one moves from low beta portfolios to the higher beta portfolios within a given size portfolio the relation was often found negative. In our study, the size was important in predicting the average returns and beta alone resulted in the decrease in the average returns when fixed for size than was earlier thought of as there needs to be positive relation with the average returns with beta.

Thus the relation of beta was negated out when not considering the size. Since Gamma 2t is significantly more than 0, it signified that size is an important contributor impacting market return, thus size contributes individually and independently of post ranking on annual and monthly average returns also, and thus the original CAPM model cannot be considered correct and the Fama and Macbeth postulates would be retained. However, this study while considering the whole market as in totality there has been a relation of the equal-weighted returns with dividends on the returns in a significant way which meant that post ranking beta may or may not impact average returns which once again does not complement the original CAPM model and further confirms Fama and Macbeth postulates.