Asset Pricing Models And Their Tests On China's Stock Market

Asset pricing lies at the heart of Financial Economics. In developed countries, asset pricing theory and empirical tests have become a well-developed system. The purpose of this paper is summarizing several important asset pricing models and deriving some useful results by using the data from china's stock market. Thus we can know the asset pricing models more and apply them to china's stock market. The whole thesis comprises seven chapters. Chapter One History Review and Articles'Summery First, from history view modern finance theory begins at the 1950s. The birth of Markowitz'portfolio theory is remarkable. From then on, asset pricing theory occupies the center role of the development of finance. Second, from methodology view, asset pricing has different methods. Depending on different logic process, asset pricing methods can be divided into induction and deductive method. Technical analysis and artificial intelligence belong to induction method and modern asset pricing models belong to deductive method. Depending on equilibrium in capital market, asset pricing methods can be divided into equilibrium method and no arbitrage method. Third, major asset pricing theories are coming out between the 1960s and the 1970s. Furthest is the mean-variance(MV) capital asset pricing model(CAPM) of Sharpe(1964), Lintner(1965), Mossin(1966) and Black(1972). The major development of CAPM is Merton's(1973) intertemporal capital asset pricing model (ICAPM),in which introducing multi-factor model for the first time. Then Black and Scholes(1973)derived the Black-Scholes option pricing formule. Ross(1976,1977) breaks up the bondage of CAPM, puts forward arbitrage pricing theory(APT). APT starts from no arbitrage assumption, figures out that returns of assets are influenced by multi independent factors, not by single factor only. Rubinstein(1976), Lucas(1978), and Breeden(1979) bring forward the consumption-based model(CCAPM). Fourth, MV CAPM is broadly tested by lots of economists. For the implication of CAPM, two statements are important: 1.there is a linear relation between the expected returns and market betas of securities -i.e. securities plot on the SML. 2.market betas are the only measures of risk needed to explain the cross-section of expected returns. The earliest test method is given by Lintner(1965), his conclusion is that CAPM is true. But Douglas(1969) found that estimated slope of SML is too flat and the intercept is too big. Miller and Scholes(1972) give the measurment error problem in the Douglas'article, and point out that measurement error in the independent variable can cause the estimated slope to be flatter than the true slope. Shortly thereafter, Black,Jensen and Scholes(1972), Fama and Macbeth(1973), Blume and Friend(1973) produce the first extensive tests of the model. Their results are consistent with Black's(1972) zero-beta CAPM. Roll's(1977) critique is the best known. Roll thinks that CAPM cannot be tested in practice. The reason is that market portfolio cannot be observable and we cannot measure the true beta. Stambaugh's(1982) evidence that tests of CAPM are not sensitive to the proxy used for the markets suggests that Roll's criticism is too strong. Wald test and likelihood ratio test developed by MacKinlay(1987), Gibbons,Ross and Shanken(1989) are important refinement methods. In addition, empirical essays about APT and Fama-French three-factor model are summarized in this chapter. Chapter Two The extensions of CAPM Since Sharpe's(1964) CAPM, Financial economists derived different equilibrium pricing models by adding or deleting it's assumptions, making the contents of CAPM richness. Merton's(1973) ICAPM and Breeden's(1979) CCAPM are two important extensions of CAPM. CAPM can also be derived under the general equilibrium, see Duffie(1988) and Jarrow(1988). In this chapter we will give these extensions'whole derivation process, in which we can understand the economic meaning behind the CAPM better. Chapter Three The extensions of APT Ross(1976) gave an intuitive derivation of APT and didn't give the strict proof. In this reason, the extensions of APT are mainly its strict proof. In this chapter we will derive APT using no arbitrage assumption, Huberman(1982) for reference. We will give out the boundary of the pricing errors in APT. Also, we can derive APT under the general equilibrium. Chapter Four Stochastic discount factor Stochastic discount factor has important significance in asset pricing. Because that the principles in asset pricing frame, if they are linear pricing principles, they must correspond to a stochastic discount factor. In this chapter we use Cochrane(2001) for reference, use stochastic discount factor derive CAPM in various conditions. At the same time we give the proof that stochastic discount factor is equivalent to the multi-factor models(ICAPM or APT).Chapter Five Empirical tests of CAPM in China's stock market First, we employed Wald test and likelihood ratio test into Shanghai's stock market. Wald test and likelihood ratio test methods are quite new, at present they are found few in domestic articles. The sample period required in the two tests is quite long, so the choose of sample stocks is restricted, the reliability of the results may be decreased. Despite it, we draw some useful conclusion: the test statistics show that the early stages of China's stock market don't conform to CAPM more. Second, we use traditional two-pass method. The results show that beta can't remarkable be the explained factors of stock returns. The correlation between beta and stock returns isn't steady. So CAPM isn't applicable in China's stock market now. Chapter six Empirical tests of APT in China's stock market First we summarized the main steps of factor analysis method, then used principle component and max likelihood factor analysis method, gave out the factor number of 200 sample stocks'daily return series in China's stock market. The results show that the factor number is 6 in the sample period, but they are not steady, when using weekly returns the factor number become 4 to the most. This indicates that factor analysis method cannot explain the economic meaning, its application is poor. Chapter seven Empirical tests of ICAPM in China's stock market Empirical tests of ICAPM is difficult, but they have success examples, Fama and French's(1992) three-factor model is one of them. We chose 400 stock data randomly from Shanghai stock market, and test them if conform to FF three-factor model in the sample period 1999-2004. The results show that Shanghai stock market conforms to FF three-factor model. The three factors'explained degree differentiates: market beta is strongest, SMB takes the second place, and HML is feeble comparably. At the same time we found that in the sample period there is no small company's effect, the average returns of big companies are bigger than small companies. Using the result into practice, we should chose big blue-chip company firstly in this market which dominated by investment funds. New discoveries of the paper First, we summarized the system of modern asset pricing theory by the numbers, took apart several important asset pricing models deeply, present the distinction and connection among these models. From different point of view, such as general equilibrium frame and stochastic discount factor, to derive the basic asset pricing models. Through this process, we deepen our understanding of the frontier of...