Multifactor pricing model: An alternative approach to CAPM

Document Type

Article

Publication Date

2007

Abstract

This study analyzes the effect of significant variables among the alternative measures of risk other than beta and establishes a framework in search of an efficient alternative to the Capital Asset Pricing Model (CAPM). Several other recent studies on this issue explore additional variables as proxies for risk in stock return and have fueled considerable debate among investors and policy-makers. Finance scholars have brainstormed and debated over the appropriate and significant proxy for risk in pricing the return of stock. Through combined univariate and multivariate regression techniques, the study analyzes data collected from http://multexinvestor.com for 1,723 firms as of the Monday, August 07, 2006. By simultaneously testing the FF (Fama-French) model on recent return data this study extends previous developments on the improvement of CAPM and broadens the scope by testing additional financial factors as proxies for risk. The statistical model developed as part of the study explains return as a function of financial variables including the price to earnings per share ratio, price to book ratio, financial leverage, dividend yield, firm size, and beta. Results were mixed with beta and price to EPS performing in line with the FF model while results for price to book, firm size, leverage, and dividend yield were contrary to FF findings. This model divulges the relevance and significance of beta, firm size, and dividend yield as independent variables determining return on stocks, which neither support nor disagree with CAPM, FF or other research supporting significance of financial ratios and keeps the scope open for further research and debate on this matter.

Original Citation

Majumdar, S., Bacon, F. W. (2007). Multifactor pricing model: An alternative approach to CAPM. ASBBS eJournal, 3(1), 72-78. http://www.asbbs.org/proceedings/Majumdar%20Bacon%20ASBBS%20EJ2007.pdf

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