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An examination of systematic risk in a scaled market model: a conceptual critique of the CAPM using a closed index system

Conference Paper


Abstract


  • The theoretical assumptions and practical limitations of the CAPM have been subjected to

    early scrutiny, however, causal relationships embedded in these data, and the index

    management practices directly affecting the characteristics of models, have been

    ignored in the empirical literature.

    Stock market indexes are effectively "closed systems" comprising relatively few ex post

    variables (i.e. security size and performance). Without invoking the CAPMs theoretical

    framework, its conjectures about security-market relationships can be scrutinised

    axiomatically. Two immediate conceptual queries arise. First, since stock market indexes

    capture the market contribution of individual securities, why is it necessary to rely upon

    statistical processes to estimate the market risk contribution of index constituents? Second,

    since index performance ex post derives from the constituents and a controlled experiment is

    conducted within a closed market model excluding "exogenous" factors, how can non-market risk arise?

    This paper analyses index constituent changes occurring within the S&P/ASX50 Index - a

    leading institutional equity index of Australia's largest and most liquid stocks between 1994

    and 2002. This identifies index turnover as an important source of statistical anomalies not

    previously documented in the literature. In addition, the efficacy of beta values is scrutinised

    using a scaled market model not afflicted by constituent turnover: this permits direct

    evaluation of security-market relationships in accordance with Markowitz original portfolio

    analysis approach. It is argued that the CAPM's theoretical specification of systematic risk is

    mistaken and that security betas are unreliable measures for their stated purpose.

Publication Date


  • 2008

Citation


  • Gold, M. L. (2008). An examination of systematic risk in a scaled market model: a conceptual critique of the CAPM using a closed index system. ESAM08 Markets and Models: Policy Frontiers in AWH Phillips Tradition (pp. 1-29).

Ro Metadata Url


  • http://nzae.org.nz/conferences/2008/100708/nr1215396767.pdf

Start Page


  • 1

End Page


  • 29

Place Of Publication


  • http://nzae.org.nz/conferences/2008/100708/nr1215396767.pdf

Abstract


  • The theoretical assumptions and practical limitations of the CAPM have been subjected to

    early scrutiny, however, causal relationships embedded in these data, and the index

    management practices directly affecting the characteristics of models, have been

    ignored in the empirical literature.

    Stock market indexes are effectively "closed systems" comprising relatively few ex post

    variables (i.e. security size and performance). Without invoking the CAPMs theoretical

    framework, its conjectures about security-market relationships can be scrutinised

    axiomatically. Two immediate conceptual queries arise. First, since stock market indexes

    capture the market contribution of individual securities, why is it necessary to rely upon

    statistical processes to estimate the market risk contribution of index constituents? Second,

    since index performance ex post derives from the constituents and a controlled experiment is

    conducted within a closed market model excluding "exogenous" factors, how can non-market risk arise?

    This paper analyses index constituent changes occurring within the S&P/ASX50 Index - a

    leading institutional equity index of Australia's largest and most liquid stocks between 1994

    and 2002. This identifies index turnover as an important source of statistical anomalies not

    previously documented in the literature. In addition, the efficacy of beta values is scrutinised

    using a scaled market model not afflicted by constituent turnover: this permits direct

    evaluation of security-market relationships in accordance with Markowitz original portfolio

    analysis approach. It is argued that the CAPM's theoretical specification of systematic risk is

    mistaken and that security betas are unreliable measures for their stated purpose.

Publication Date


  • 2008

Citation


  • Gold, M. L. (2008). An examination of systematic risk in a scaled market model: a conceptual critique of the CAPM using a closed index system. ESAM08 Markets and Models: Policy Frontiers in AWH Phillips Tradition (pp. 1-29).

Ro Metadata Url


  • http://nzae.org.nz/conferences/2008/100708/nr1215396767.pdf

Start Page


  • 1

End Page


  • 29

Place Of Publication


  • http://nzae.org.nz/conferences/2008/100708/nr1215396767.pdf