Bachelor of finance and banking thesis the test of CAPM in vietnam stock market

MINISTRY OF EDUCATION AND TRAINING FPT UNIVERSITY Bachelor of Finance and Banking Thesis The Test of CAPM in Vietnam Stock Market GROUP 8 GROUP MEMBERS VõThịMỹLinh - FB60224 TiếtKhaiNguyên - FB60019 ĐỗDuyHòa- FB60041 DươngHữuTrí- FB60008 SUPERVISOR NguyễnThụyNgọcDuyên EXT SUPERVISOR GRADUATION THESIS CODE Ho Chi Minh City, 8/2014 TABLE OF CONTENTS LISTS OF TABLE Table 3.1: The government 2-year bond rate and default risk Table 4.1: The number of listed stocks in the sample Table 4.2: Regression results on the CAPM by price return method Table 4.3: Regression results on the CAPM by total return method ABBREVIATION AMEX : American Stock Exchange APT : Arbitrage Pricing Theory BE/ME : Book equity value/ Market equity value BH : portfolio of big size and high book to market equity BL : portfolio of big size and low book to market equity BM : portfolio of big size and medium book to market equity GROUP 8 Page 2 CAPM : Capital Asset Pricing Model CFA : Chartered Financial Analyst CRSP : The Center for Research in Security Prices in US CSMAR : China Stock Market and Accounting Research Database HML : High minus low HNX : Ha Noi Stock Exchange HSX : Ho Chi Minh Stock Exchange KIBOR : Karachi Interbank Offer Rate KRX : Karachi Stock Exchange KSE : Korea Stock Exchange MAVA : The mean absolute value for the alphas MSCI : Morgan Standley Capital International NYSDAQ : The National Association of Securities Dealers Automated Quotation NYSE : The New York Stock Exchange SH : portfolio of small size and high book to market equity SL : portfolio of small size and low book to market equity SM : portfolio of small size and medium book to market equity SMB : Small minus big SML : Security Market Line UPCOM : Vietnam over the counter market β : Beta GROUP 8 Page 3 ABSTRACT This study provides a traditional valuation technique in estimating the risk and expected return of assets in the stockmarket. Specifically, this paper discusses the challenges of applying Capital Asset Pricing Model (CAPM) model techniques in Vietnam stock market, one of the major Asia frontier markets. The sample size is picked about 150 stocks from the HSX for testing, and the sample periods being from March, 2012 to March, 2014. With corresponding monthly yield data, the study uses quantitative method such as Central Limit Theory and Point Estimator that the CAPM model is estimated and tested by using time-series test and cross-sectional regression. On many fronts, our findings show that there is not substantial alignment with CAPM valuation practices in Vietnam's stock market because the Vietnam stock market is not mature, GROUP 8 Page 4 the market has been speculative and stock prices were easily controlled.Besides, the following research may eliminate the limitations of this study in order to get better results. Keywords: CAPM, Vietnam stock market, valuation. CHAPTER 1 - INTRODUCTION 1. Background Vietnam stock market has been appeared and developed more than 10 years, but it still is an frontier capital market that lack of the significant information of financial organizations and doesn’t have many tools or models that help in getting the investor wealth maximization and assessing the level of risk accurately. Following Damodaran(2002), there are three different approaches to valuation of a publicly traded stock. Firstly, discounted cash flow is the foundation to analyze and use the other approaches through calculating the present value of asset based on the future expected cash flow on that asset. Secondly, relative valuation estimates the value of asset by comparing the pricing of asset to a common variable such as book value, earnings, cash flows or revenues and it is the approach that is the most valuation done in the reality. Thirdly, contingent claim valuation that is known as the revolutionary development in valuation in recent years uses option pricing models to determine the value of assets.However, these approaches are quite sophisticated and the majority of investors in GROUP 8 Page 5 Vietnam stock market are individuals who don’t have enough time and specialist knowledge to use. Therefore, they tend to base on the company’s published information or recommendations of security organizations when they consider and look for investing in an industry or a stock. For the above reasons, it is really necessary for Vietnam market to apply a model that can determine expected return and risk of a stock and provide a helpful and efficient method for investors. CAPM was developed by William Sharpe (1964), John Lintner (1965) and Jan Mossin (1966) independently. It describes the relationship between the systematic risk that the investment adds to a market portfolio (presented by (β)) and expected rate of return on an asset. Although CAPM has been doubted about its application in many empirical studies in recently years, it is still the fundamental model in most real world analysis. Because CAPM can help investors in classifying stocks, avoiding risk and realizing return through β. Besides, CAPM also provide investment guidance to investors through estimating risk-return trade-off, investors can explore if stocks are undervalued or overvalued in order to make decisions. The CAPM model can be represented as: Where: : The expected return of the stock i. : Risk-free rate (of assets from which the expected returns are certain) : The expected return on the market portfolio : The degree of systematic risk of firm i’s stock returns relative to the risk of the (stock) market portfolio’s returns. SML is the representation of CAPM. It displays the risk – expected rate of return of an individual stock under the condition of an efficient market. In SML, the vertical axis is the risk-free rate, the horizontal axis represents the β and the slope of SML is. This is a helpful tool to consider whether investors should invest in a stock or not. Every stock is plotted on the SML individually. If a stock is above SML, it means that this stock is undervalued because GROUP 8 Page 6 with a given amount of risk (, investors get higher return. Conversely, if a stock is below SML, it is overvalued because we get lower return with a given amount of risk. Based on the model of CAPM, for any individual stocks, we can realize that the expected return will increase when increase, therefore, it is a positive relation between the value of and the expected return of stock in the market. 2. Theoretical problems The model always starts with the necessary assumptions that have the effect to simplifying but still ensure not change the nature of the problem. In general, CAPM also ignores some complexities of financial market to obtain the linear relationship between risk and expected return. According to Sharpe-Lintner, there are seven assumptions when applying CAPM: • Investors are risk-averse, utility-maximizing, rational individuals. • Markets are frictionless, including no transaction cost and no taxes. • Investors plan to invest for the same single holding period. • Investors have homogeneous expectations or beliefs. • All investments infinitely divisible. • Investors are price takers. • The investors can borrow and lend unlimited amount at the risk-free rate GROUP 8 Page 7 There are some problems arose from conducting CAPM structure model and assumptions as follows. Firstly, CAPM is based on single-factor model that just use systematic risk () and eliminate no other investment characteristics in estimating expected return of assets. Therefore, CAPM may not evaluate the entire risk although it is easy to understand and apply. Secondly, CAPM is applied in a single - period model that does not consider multi-period implications because β is calculated based on the historical stock price. Thus, β in the current period may be negative for the future investment objectives. Although CAPM makes the restricted assumptions about how markets work and do not perfectly suitable for the realistic situation, the model requires little inputs. Under these assumptions, it helps investors in obtaining the risk-return, and generating the efficient asset pricing model. 3. Practical problems In addition to the theoretical limitations, implementation of the CAPM raises several practical concerns, some of which are listed follow. Firstly, Richard Roll (Richard Roll critique 1977) mentions one reason that CAPM is not estimated accurately about a true market portfolio because all investable asset and non-investable asset is hardly to be observable. For example, it is difficult to contain assets in closed economies or nonfinancial. Secondly, proxies for a market portfolio used by market participants caries among analysts, the country of investors… that generates different estimated return for the same asset, which is impermissible in CAPM. Thirdly, estimate for long history of return may be inaccurate representation of the current or future state of company (time-period bias). Because of the different estimation of β from different period, CAPM may estimate different risk-return for same asset. For example, a two- year β is unlikely to be the same as a six-year β. Fourthly, CAPM cannot determine asset returns by non-systematic risk. So that in empirical study support for CAPM is weak, and it gives poor predictability of returns. Fifthly, there is obvious to not be similar to CAPM assumptions that assume investors have the same expectations for a single optimal risky portfolio. In fact, the different investors have different expectations for the same asset. 4. Research questions  Is Capital asset pricing mode valid in Vietnam stock market? GROUP 8 Page 8  How does the systematic risk () influence to the investor’s the expected return? Positive or negative correlation?  Dividend can increase the compatibility of CAPM in Vietnam stock market? 5. Research objectives The study focus on testing whether CAPM suitably apply for Vietnam stock market Firstly, systematize the basic theory of CAPM and review some empirical tests. Secondly, estimate of stocks in HSXthrough two methods: price return and total return. Thirdly, clarify the affect’s dividend and test relationship between risk and return. Finally, make conclusion and recommendation. 6. Research scope With research objectives, the study just focuses on analyzing and processing the sample data to determine the risk and expected return based on CAPM. After that, recommendations will be made through the results. This study will not analyze the factors of the market that affect to the investor decision making. All decision depends on skills and hobby of each investor. The sample data of this study are gathered through the company in Vietnam stock market (including only the stocks that are traded on HSX). From the data about capital market of these companies, we will use normal distribution and then pick the absolute size to decide a suitable sample size. The time period will be taken from March, 2012 to March, 2014. 7. Methodology and data overview To verify the application of CAPM in Vietnam, the study gathers data from public firms registered on HSX through statistical tool and using point estimator to choose study sample size. The research period is from March, 2012 to March, 2014. There are three independent variables (risk-free rate, β, and risk premium) and one dependent variable (expected return of stock). Each independent variable is practiced via different methods. The result of risk-free rate and risk premium are based on AswathDamodaran estimation methods.β is estimated through regression linear method that shows the relationship between systematic risk and return on specified stock. GROUP 8 Page 9 After gathering and processing database, the study uses descriptive statistic to test whether CAPM is suitable model when applying in HSX. The study uses some statistical software such as Excel, Eview. 8. Thesis outline This study is conducted to test the application of CAPM in Vietnam stock market from the end of March, 2012 to the end of March, 2014. This study contains 5 main chapters: Chapter 1 mainly provides the background and the introduction of the objective of the study. To specific, this chapter will introduce the CAPM, state the CAPM theoretical problems and practical problems, clarify research question and objectives, and give an overview about methodology and data. Chapter 2 discusses the different versions of CAPM including Sharpe and Lintner version, Black version. Describe three factors model Fama and French.Give the evidences about testing CAPM in different markets that have the methodology related to this study. Chapter 3 states the data collection methods and the methodology of this study, and then processes the data source characteristic. Chapter 4 provides the result of the study, systematize presentation and analyze the result. Chapter 5 will provide the conclusion of the compatibility of CAPM in Vietnam stock market and make recommendations. GROUP 8 Page 10 [...]... both CAPM and three factor model cannot rejected On the other hand, the study 3.4 tests the validity of CAPM in China stock market, and the result of study is insignificant and β value cannot apply to present the expected return accuracy To contrary, the study 3.5 is also the rejection of CAPM in Pakistan stock market when using hypothesis for determining the explanatory power of CAPM in estimating... rate of return for stock without dividend (1) (2) Where: :The dividend value in period from month t-1 to month t : The closing price of month t : The closing price of month t-1 2.2.5 Rate of market return VN Index is the market index of Ho Chi Minh Stock Exchange that reflects the market trend and is determined through the weighted average of all stocks in the market In the empirical tests of CAPM, the. .. the return of market because this index reflects the market trend for both of the stock exchanges), and apply a two-step regression to actualize the whole examination In the first step of regression, the study calculated the β of 90 stocks of the sample through conducting a regression between the return of the stocks and the return of the market index by using a time series analysis In the second step... uncertain results of previous studies, Fan Wang (2013) did a research “A test of CAPM in China’s Stock Market to answer the question whether or not CAPM is the correct model for the emerging stock market as China To specific, the objective of the study is to examine the relationship between the expected return and risk of stocks Being along with this purpose, the study focus on the test of CAPM on China... verification of the real relationship between the expected return and risk of financial asset, and stock is the mainly asset in the discussion of study Nevertheless, the versions of CAPM have been required too many assumptions in using the model, thus, it does not hold the hypothesis in the real world Accordingly, the researches about the testing and rejection have contributed many new factors, including those... superiority the three factor model For other sample test such as study 3.2, J Bartholdy and Peare provide the result the CAPM work much better than the three factor model for estimating the expected return of individual stock Secondly, the study examines the validity of CAPM in emerging and developed markets Inspecifically, the study 3.3 tests CAPM and three factor model in U.S developed markets, and the result... been presented in the previous studies, especially in the study of Fan Wang (2013) in China The study will execute the testing of CAPM on Vietnam stock market, but it is not completely identical to the distribution of sample data by portfolio industries; this article will set sample data by individual stocks Due to the limited scale in Vietnam stock market and the limitation of the article, the study will... rate of return on the stock market The research had used Karachi Interbank Offer Rate (KIBOR) as the risk-free rate that is used benchmark with a high degree of certainty andis obtained actual quarterly return on individual stock and stock market The author had used regression analysis to test the hypothesis; and the result is to reject the null hypothesis that the intercept when CAPM is imposed on the. .. these authors found the relationship between the return and risk of the portfolio This means that the higher risk get the higher return Conversely, the other authors doubt about the validity of the CAPM on the basis of their empirical researches In historical, the rejected studies of the CAPM by author Richard Roll (1977) in study “A Critique of the Asset Pricing Theory's Tests” and Engene F Fama and. .. and testing period In contrast, study 3.2 show the result of CAPM for individual stock is more validity Besides, the study 3.3, 3.4 and 3.5 show the CAPM is valid or not in different market, such as study 3.3 CAPM and three factors modelsare valid in U.S stock market, study 3.4 and 3.5 stated that CAPM cannot apply for China stock market and Pakistan stock market in turn So that the validity of CAPM still . MINISTRY OF EDUCATION AND TRAINING FPT UNIVERSITY Bachelor of Finance and Banking Thesis The Test of CAPM in Vietnam Stock Market GROUP 8 GROUP MEMBERS VõThịMỹLinh - FB60224 TiếtKhaiNguyên. markets, and the result stated that both CAPM and three factor model cannot rejected. On the other hand, the study 3.4 tests the validity of CAPM in China stock market, and the result of study is insignificant. return of individual stock. Secondly, the study examines the validity of CAPM in emerging and developed markets. Inspecifically, the study 3.3 tests CAPM and three factor model in U.S developed markets,