An evaluation of the capital asset pricing model for the Nairobi Stock Exchange: an econometric approach

There have been innumerable empirical studies conducted to test the validity of the Capital Asset Pricing Model (CAPM) since its naissance. However, few have considered the Sub-Saharan African stock markets. This paper examined the validity of the CAPM for the Nairobi Stock Exchange. In this study, instead of identifying more risk factors, a detailed analysis of single risk factor was undertaken. The study used weekly stock returns from 30 companies listed on the Nairobi Stock Exchange from 2003.01.01 to 2007.l2.31. The purpose of this paper was to examine whether the CAPM holds true in the Kenyan stock market by testing whether: (i) the intercept equals to zero, (ii) the rate of return is linearly related with its beta and effect of quadratic form of beta and (iii) non-systemic risk affects the stock returns. First, there is very strong evidence that the Nairobi Stock Exchange upholds the proposition that there is no risk premium for bearing nonsystematic risk. Secondly, there is weak support from the NSE, supporting the CAPM proposition that there exists a linear relationship between risk and return. Thirdly, by adding a quadratic form of p, it seems as this structural improvement has a statistically significant effect on the regression, demonstrating that there exists a statistically significant relationship between stock returns and the beta squared factors. Finally, we are indifferent as to whether non-systematic risk significantly affects stock returns or not. From the above, we conclude that, the empirical work on the Kenyan stock market during 2003.1.1 to 2007.12.31 supports the CAPM to a large extent, though not fully.