Evaluation of Asset Pricing Models in the South African Equities Market

Moyo, Nigel A P

Evaluation of Asset Pricing Models in the South African Equities Market

Master Thesis

2020

Abstract

Asset pricing models have been of interest since their origin in modern finance. The Capital Asset Pricing Model is a widely used tool and is one of the early developed asset pricing models in modern finance. There are continual improvements of this model with the evident multifactor models of Fama and French (2015), Carhart (1997) and the South African two – factor arbitrage pricing models of Van Rensburg (2002) and Laird-Smith et al. (2016). This research empirically investigates the performance of eight-different multi-factor asset pricing models in describing average portfolio returns in the South African Johannesburg Stock Exchange. We find that the Carhart (1997) four factor model comprising of the market factor, size factor, value factor and the momentum factor is the most parsimonious model and thus better explains the average portfolio returns in the South African JSE. This model is an improvement of the Fama and French (1992) three factor model. Additionally, we investigate the performance of the two factor Asset Pricing Theory (APT) model of Laird-Smith et al. (2016) and Van Rensburg (2002) that consists of the South African Financial Index (SAFI) and the South African Resources Index (SARI). We observe that the model performs better than the traditional CAPM that is widely used in industry. Adding the SAFI and the SARI to the six-factor model results in an eight-factor model that has a significant improvement in explaining average returns. The results indicate that the market factor, the South African Financial Index and the South African Resources Index (SARI) poorly explain each other but their linear combination improves the eight-factor asset pricing model in explaining average portfolio returns in the South African market. The eight – factor model comprises of the market, size, value, investment, profitability, momentum factors and the two South African indices namely, the South African Financials Index (SAFI) and the South African Resources Index (SARI).