Capital asset pricing model (CAPM) applicability in the South African context and alternative pricing models

Abstract

The ability to accurately price equity is an ineluctable requirement within businesses where decisions need to be taken daily that impact upon the future viability of that business. The Capital asset pricing model (CAPM) is the preeminent tool that has become entrenched within academia and business for exactly the purpose of costing equity capital. This study aimed to prove whether the application of the CAPM, in various forms, including the Black s CAPM, was merely a myopic inculcation of the academic and business spheres, or whether it truly reflected the empirical reality of the South African markets. The research discredited eight variations of the CAPM through a quantitative causal design, which employed t-tests and ANOVAs, tested upon a judgmental sample of the largest 160 shares on the JSE. Reaching this opprobrium would have been a Pyrrhic victory, had an alternative model not been proposed. Thus, a quartet of styles was employed in tests against both non-resource and resource shares in an attempt to generate two multi-factor models known as the Optimised Returns Score (ORS) combined models. The generated model for the non-resource shares explained 36.5% of the variation in the observed cost of equity capital, at a 95% level of significance. However, a statistically significant predictive model for resource shares was unable to be found, possibly due to the small sample size available.