Capital Asset Pricing Model (CAPM) was introduced by William Sharpe (1964), Jan Mossin (1966) and John Lintner (1969) separately. This model has been regarded as a great contribution to financial economics. According to Fama and French (1992), “the model has long shaped the way academics and practitioners think about average return and risk”. In practice, it is the most used investment model by fund managers and analysts to determine risk and return of assets. Because of CAPM’s importance in the world of finance, it has been largely tested and its validity has become debatable. Earlier testing of CAPM by Lintner(1965), Black(1972) and Fama and Macbeth(1973) found a strong positive relationship between return and risk (measured by beta). But not all empirical studies have achieved the same results. For instance, Corhay et al (1987) found no relationship between beta and returns for US, UK, France and Belgium for the period of 1969-1983. Similarly, Fama and French (1992) found no relationship between US beta and returns over the period of 1963-1990 and only a weak one from 1941-1990(Fabozzi, 2002). Fama and French claimed that other factors other than beta explained the returns contrary to CAPM. Their research showed that size and book-to-market equity were a more appropriate measure of risk, since they significantly explained cross-sectional changes in average returns. The importance of size and book-to-market equity has been extensively tested in Developed markets as well as emerging markets such as Hong Kong and Japanese. Moreover, further studies on the relationship of beta and returns have also been tested in US, UK, French, Hong Kong, Swiss, Australian, German, Argentina, Brazil, Chile and Mexican markets (Morelli 2007). But none of such research has been tested using Africa’s data. This research aims to apply a similar empirical test on South Africa’s market data to explore the relationship between average share returns and these variables; beta, size and book-to-market equity. Since, this will be the first comprehensive study of this kind on an African emerging market, it looks promising. The finding will give an insight into the behavior share returns in Africa emerging capital markets which could aid investment and financial decision-making. Moreover, since I have a keen interest in stock market investments, a discovery of the factors that truly affect returns in my part of the world, will not only place me at an advantage of managing portfolios constructed in such markets that could yield high return, but also keep me motivated to start and finish the research.
The two most important attributes of every investment is return and risk (Rutterford and Davison 2007: 40). The goal of every investor, who is usually assumed to be risk-averse, is to maximize the return on investment while minimizing the likelihood that the expected return will be achieved, that is, risk. There is a lot of the existing literature on the effects of risk on stock investment returns and models have been development to explore this relationship.
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