Testing the Validity of the Capital Asset Pricing Model and Existence of Market Volatility: An Analysis of the Ghana Stock Exchange

Abstract

Volatility and the risk-return trade-off of equities or stock market play essential role in investment, decision making and financial stability among others. This study proposes to test the validity of the capital asset pricing model and existence of market volatility in the Ghana Stock Exchange (GSE). An investigation of eight companies listed on the GSE and market returns of GSE was done through a secondary data collected on daily basis from 4th January 2010 to 31st December 2018. The CAPM is tested on portfolios by adopting the Fama and Mcbeth (1973) two-stage regression methodology using GARCH (1,1) model in estimating the time series regressions present in the study. The study however found that in as much as the use of portfolios addresses the flaws associated with individual securities in testing the validity of CAPM, it is invalid in the GSE, as market and firm-specific risk have significant effect on the average portfolio returns of investors. The findings also revealed the GSE is mean reverting and takes a longer period (35 days) for the market to be stable overtime. The study recommends that the Central Bank of Ghana must ensure risks, which are almost inevitable, are properly priced by considering the impact they have on the economies. Also, with GSE being volatile, investors must consider day trading to avoid too many losses.