Applications and extentions of financial models to small markets : the South African case

Doctoral Thesis


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University of Cape Town

ORGANIZATION OF THESIS: In Chapter 2, the important contributions to the development of Capital Market Theory will be discussed. Greater emphasis will be given to the more classical contributions and only a brief outline of the mathematical development will be presented where it is deemed necessary for the ensuing development of the thesis. In Chapter 3, a modified approach for portfolio selection in thinly-traded environments is proposed. This proposal concentrates on improving estimation of the inputs for practical implementation of the usual Markowitz portfolio selection routine. The estimation procedure adopted makes corrections for thin-trading and also makes use of the CAPM to improve the vector of return inputs. Chapter 4, basically consists of four sections. The first, gives a brief outline on historical estimation problems associated with the market model. In the second section the extent of thin-trading is investigated on the JSE. Furthermore a suitable beta estimation procedure which corrects for the effects of thin-trading is investigated empirically. In the third section an extended market model is proposed. This model leads to a more detailed, yet tractable structure of the risk components of stocks on smaller markets. An empirical investigation is subsequently conducted to investigate the risk structure of JSE stocks. In the last section of Chapter 4, an example of an empirical study using risk-adjusted returns is presented. The example considers the choice between bullion and South African gold shares from the international diversification perspective. In Chapter 5, empirical tests of the CAPM are conducted. This chapter consists of 2 main sections, namely, univariate tests and multivariate tests of the CAPM. Both of the tests also consider possible extensions of the CAPM by encorporating additional factors in the tests. Chapter 6 represents the main focus of this thesis, here the power of the univariate and multivariate tests of the CAPM are investigated using a simulation approach. The power investigation is conducted on simulated data that charaterizes the NYSE, however the JSE parameters are also considered. In the final section of this chapter the power of these tests are compared using various structured residual variance-covariance matrices. Lastly, some final thoughts and directions for future research are offered.

Includes bibliography.