CAPM Specifications for tests of Market Efficiency

What is it about?

In this paper, we examine specifications of the Capital Asset Pricing Model (CAPM) that appear to be efficient in so far as ability to explain the cross-section of expected returns within the Nigerian Stock Exchange (NSE). Our findings indicate a model that incorporates the first two higher moments of returns - variance and skewness - and a factor for idiosyncratic risk is most efficient at describing the cross-section of expected returns. Our findings provide evidence that non-synchronous trading of stocks is associated with higher levels of risk aversion and the resultant increase in minimum returns demanded by investors. These findings on the effects of non-synchronous trading imply liquidity risk attracts a significant premium on the Nigerian Stock Exchange. Our finding that non-synchronous trading eliminates demand for a riskless security indicates, however, that it confers diversification benefits on investors.

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Why is it important?

Empirical tests that attempt to determine whether stock markets are efficient in so far as investors' responses to new information are concerned require an asset pricing model that is efficient in so far as ability to describe the cross-section of stock returns is concerned. The identification of an efficient asset pricing model is thus crucial for assessments of the efficiency of time series changes in stock prices. In this study, we identify one model that can be characterized as efficient.

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