Evaluating the Effectiveness of the Capital Asset Pricing Model (CAPM) in the Kenyan Capital Market

Abstract

The purpose of this study was to evaluate the effectiveness of the Capital Asset Pricing Model in describing the behaviour or return of securities traded in the Kenyan capital markets. By developing the general. equilibrium relationship of CAPM, this study tested whether observed returns were more consistent with the current market trend than they are with the standard CAPM. The researcher applied the methodology of comparative study of the two variables; observed returns as the independent and expected as the dependent. The study covered 20 companies trading in the Nairobi Stock Exchange for the period starting January 2004 and ending June 2005. The response observed from the 20 firms indicated weak evidence of the effectiveness of the Capital Asset Pricing Model in predicting the values of individual securities. This appears to be a universal phenomenon as compared to findings in other economies. These results reflect the inability of the general form of the Capital Asset Pricing Model on strongly predicting the value of securities in the Kenyan Capital Markets. There is therefore need to study other forms and rigor of the model as well as other valuation models to determine a most table method of valuation in Kenya.