A Test of CAPM on the Karachi Stock Exchange

This study investigates the applicability of the CAPM in explaining the cross section of stock return on the Karachi Stock Exchange for the period September 1992 to April 2006. Unlike earlier studies on emerging markets this study is carried out with a broader scope. Firstly, the tests are conducted on individual stocks as well as size sorted portfolios and industry portfolios. Secondly, the test accounts for the intervalling effect by employing three data frequencies namely daily, weekly and monthly data. Thirdly, keeping in view the infrequent trading prevailing in emerging markets in general and Pakistan’s equity markets in particular the test is also carried out on beta corrected for thin trading, using the Dimson (1979) procedure. Contrary to earlier studies on emerging markets the premium for beta risk and the skewness have the expected signs. The risk return relationship however appears to be non-linear and is most profound in recent years when the market performance, backed by the high level of liquidity and trading activity, was outstanding. JEL Classification: G1, C24