Beyond CAPM Beta: Measures of Risk in Portfolio Risk-Return Analysis

GLOBAL FINANCIAL MANAGEMNT

PROJECT REPORT
ON
Beyond CAPM Beta: Various Measures of Risk in Portfolio Risk-Return Analysis

SUBMMITED TO:

BY:

Dr. T. Sridhar

Sayan Das (1226110137)

R. Sucharita (1226110130)
Avisekh Prasad

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Beyond CAPM Beta: Measures of Risk in Portfolio Risk-Return Analysis

I. DATA AND RISK METRICS SUMMARY ANALYSIS
Summary
We examine average returns and risk measures in a sample of 20stocks using data from Bombay
Stock Exchanges (BSE). The sample consists of 10mid cap stocks and 10 large cap stocks.
The data are sampled between Januarys 2005and December 2010. There are a number of mid cap
and large cap stocks whose data do not begin until later, but we include only stocks that have a
history at least from January 1995.
Risk Metrics
A variety of risk metrics are used to explain the average returns. The notation is detailed here.
For example, the materials we have worked with are the average total returns in %age [(P1PO)/P0] for the stock i, which we express as E[Ri].
CAPM Model:
Using a CAPM model, where R(m) denotes the return on the BSE-100 index, we estimate the
regression:
Ri rf = ai + bi[Rm rf] + e (1)
where rf is the India 91-day Treasury bill rate, and ei is the residual. SR (systematic risk) is the
beta, bi in equation (1). TR (total risk) is the standard deviation of stocks return i. IR
(idiosyncratic risk) is the standard deviation of the residual ei.
Size: For size (market capitalization), we take the natural log of average market capitalization
over the relevant period for each stock.
Semistandard Deviations. The formula for semistandard deviation is: standard deviation of all
those stocks whose return are less than the mean of Rm (f or semidtandard deviation-Rm) and
less than the mean of Rf (for semidtandard deviation-Rf).
Downside Beta Measures. Down- im is the result of covariance(i.m) divided by variance(m)[formula 1] using observations when stock returns and market returns are simultaneously
negative.

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Beyond CAPM Beta: Measures of Risk in Portfolio Risk-Return Analysis

Down-i is the result of covariance(i.m) divided by variance(m) using observations when
stock returns are negative.
Skewness: Skew is the unconditional skewness of returns. It is calculated by taking the
Mean(Ri3) divided by the [Standard Deviation of (Ri)]3-formula 2.
For this report we calculated skewness on Excel with the function SKEW(Ri).
Coskew represents coskewness definition. It is calculated by (sum up Ri*Rm2)/T and divide by
[square root of (sum of (Ri2)/T)]* [(sum of (Rm2)/T)]- formula 3.
Spread. Kurt is the kurtosis of the return distribution.
II. SUMMARY STATISTICS
Exhibit 1A (Mid Cap Stocks) and Exhibit 1B (Large Cap Stocks) present some summary
statistics for the risk measures over the complete sample for each stocks. We report the mean
monthly stock returns (10-10 each for mid cap and large cap stocks) in addition to the average
values of the risk measures.
The last row of each exhibit reports the average across all stocks. We see the usual
characteristics. Mid cap Stocks are more volatile and generally have more risk on the downside
(as measured by the semi-standard devaiation, VaR, downside betas).
Exhibits 2A-2C present the correlation matrices of the risk measures of mid cap stocks, large cap
stocks, and all stocks. There are some interesting findings.

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Beyond CAPM Beta: Measures of Risk in Portfolio Risk-Return Analysis

EXHIBIT 1A
Summary Statistics (Monthly Stock Return)- Mid Cap

Stocks/Variables
Mean Return
SD
Variance SSD-Rf SSD-Rm Skew Kurt Co-SkewBeta Residual D Beta1 D Beta2 Size
Ashok Leyland0.02165 0.13645 0.01862 0.11621 0.09694 0.17775 1.61377 2.2254 1.11188 -0.036 0.73281 1.02609 24.7617
Berger paints0.02186 0.13916 0.01937 0.02113 0.01808 0.27265 3.90194 0.27924 0.66209 0.01592 0.24414 0.66412 23.5391
crisil
0.01675 0.09 0.0081 0.08938 0.09054 -0.2104 2.40216 0.03132
1 1.89E-18 0.98611 0.98611 23.8268
ESSAR
0.03962 0.30205 0.09123 0.302 0.302 3.577 20.471 0.0038 1.5406 0.3579 0.8909 1.3236 24.2252
exide
0.02058 0.15468 0.02393 0.17054 0.16148 -2.6167 15.5268 4.2E-05 -0.0669
0 -0.0675 -0.0685 10.6304
federal bank 0.01904 0.12319 0.01518 0.12346 0.12237 -0.1408 1.13455 0.00223 1.00797 0.08335 0.99859 0.00044 24.172
gillette india 0.01979 0.11212 0.01257 0.12411 0.11841 1.56949 9.63307 -3E-05 0.00722 3.18E-17 0.00729 0.00526 10.9626
godrej
0.01045 0.12659 0.01602 0.10457 0.09793 -2.1429 14.4173 -9E-05 0.36884 12.2984 0.36884 -0.2825 12.7693
mrf ltd
0.0313 0.19142 0.03664 0.14413 0.13692 2.6888 14.5028 0.19397 1.46377 0.19506 0.68837 0.80703 23.4272
p&g
0.01536 0.07774 0.00604 0.09273 0.08159 1.33867 3.79774 -1E-06 0.34274 7.18119 0.34938 0.05768 10.3492

EXHIBIT 1B
Summary Statistics (Monthly Stock Returns)- Large Cap

Stocks/Variables
Mean Return
Variance SD
SSD-Rf SSD-Rm Skew Kurt Co-Skew Beta Residual D Beta1 D Beta2 Size
Axis Bank
0.0363 0.01673 0.12935 0.15648 0.1116 -0.056 0.59406 3.1086E-04 1.16178 3.85E-18 1.17184 0.76598 11.936
BHEL
0.02297 0.01421 0.11919 0.12595 0.1169 -0.476 2.71451 1.5761E-04 0.85988 2.15E-17 0.86732 0.85321 13.446
Blue Star
0.03809 0.01805 0.13435 0.1536 0.1493 0.976 6.86703 3.5689E-04 1.14747 1.21E-17 1.15741 1.13785 9.9028
Colgate-Pamolive
0.02507 0.00608 0.07797 0.09035 0.0746 0.4711 1.64115 -3.4436E-05 0.23969 -0.03418 0.24176 0.23601 10.963
IOCL
0.01858 0.02858 0.16907 0.18071 0.1718 0.4811 3.95641 4.0641E-04 0.5679 1.26E-17 0.57282 0.56317 13.315
Jindal Steel 0.06149 0.04158 0.2039 0.22821 0.2307 2.8219 17.6928 2.1022E-04 1.57045 2.7E-18 1.57944 1.57944 12.036
Madras Cements
0.01874 0.01678 0.12954 0.13922 0.1299 0.3784 1.63189 1.2278E-04 1.03752 9.06E-18 1.04651 1.03035 10.194
Radico kahitan0.02468 0.01739 0.13188 0.14303 0.1331 0.1322 0.63167 2.0882E-04 0.82213 2.27E-17 0.82926 0.8155 9.397
Tata Steel 0.02236 0.0291 0.17058 0.18009 0.1693 0.5334 3.50707 2.1748E-04 1.63388 2.16E-17 1.64803 1.62328 12.759
Whirlpool 0.05351 0.03762 0.19397 0.17871 0.1751 0.7619 1.19704 2.5036E-04 1.19023 4.43E-18 1.20054 1.17889 8.8041

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Beyond CAPM Beta: Measures of Risk in Portfolio Risk-Return Analysis

BSE Data. E[R]: Mean returns; Beta: Systematic risk; SD: Total risk; Residual: Idiosyncratic risk; Size:
Log of average market cap; SSD-Rm: Semistandard deviation with respect to mean; SSD-Rf:
Semistandard deviation with respect to risk-free rate; D Beta1: Downside beta calculated using
observations when stock return falls(Down-i); D Beta2: Downside beta calculated using observations
when stock return and market return fall simultaneously(Down-iw); Skew: Skewness; Coskew:
Coskewness with world index using formula 2, Kurt: Kurtosis.

III. REGRESSION ANALYSIS

EXHIBIT 2A
Cross Section Analysis Correlation Matrix- Mid Cap Stocks

Mean Return SD Variance

Mean Return 1
SD
0.901705
1
Variance 0.892296 0.983084
1
SSD-Rf 0.724189 0.828151 0.861285
SSD-Rm 0.728822 0.833437 0.870362
Skew
0.74207 0.512185 0.572603
Kurt
0.523832 0.737928 0.71192
Co-Skew 0.036346 -0.03465 -0.08498
Beta
0.664788 0.569743 0.573779
Residual -0.55149 -0.26803 -0.22756
D Beta1 0.308697 0.244955 0.292095
D Beta2 0.702722 0.544096 0.569601
Size
0.501117 0.380844 0.356454

SSD-Rf SSD-Rm Skew

1
0.996666
0.415362
0.727606
-0.12346
0.362454
-0.17835
0.236292
0.323667
0.079507

1
0.422759
0.728902
-0.18267
0.373604
-0.18889
0.258048
0.327262
0.099583

1
0.180038
-0.01942
0.599221
-0.32375
0.350167
0.593003
0.368092

Kurt Co-Skew Beta Residual D Beta1 D Beta2

1
-0.37026
0.036737
0.14546
-0.23709
0.029103
-0.24343

1
0.266231
-0.20883
0.181995
0.401528
0.3733

Size

1
-0.32328
1
0.862026 -0.1919
1
0.802545 -0.5299 0.591766
1
0.883514 -0.52236 0.799004 0.779323

Bivariate Regression
The main regression results are presented in Exhibit 3. These regressions examine the bivariate
relation between the average returns and various risk measures. The first set of regressions is the
classic world CAPM. The analysis shows a significant relation when all 20companies are

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Beyond CAPM Beta: Measures of Risk in Portfolio Risk-Return Analysis

included. Interestingly, the intercept is not significantly different from zero. This evidence would
seem to support the CAPM.
EXHIBIT 2B
Cross Section Analysis Correlation Matrix- Large Cap Stocks

Mean ReturnVariance
Mean Return 1
Variance 0.659017
1
SD
0.601828
0.99
SSD-Rf 0.611985 0.938522
SSD-Rm 0.599406 0.949007
Skew
0.7379 0.682201
Kurt
0.626365 0.582669
Co-Skew 0.166279 0.44217
Beta
0.515115 0.656561
Residual 0.166769 0.519948
D Beta1 0.513563 0.655538
D Beta2 0.488309 0.707236
Size
-0.3003 0.02719

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SD

1
0.952655
0.952734
0.617794
0.537922
0.531248
0.692895
0.628255
0.692137
0.733254
0.037646

SSD-Rf SSD-Rm Skew

1
0.96028
0.704701
0.680097
0.584247
0.737035
0.632778
0.735907
0.738224
0.15453

1
0.76482
0.737504
0.489871
0.680761
0.582816
0.679467
0.760289
0.08264

1
0.906474
0.080321
0.46886
0.052367
0.466566
0.549019
-0.08915

Kurt Co-Skew Beta Residual D Beta1 D Beta2

1
0.138545
0.473088
0.163598
0.470647
0.546523
0.222517

1
0.320474
0.716289
0.321067
0.242501
0.126187

1
0.648106
1
0.999995 0.648725
1
0.958202 0.608019 0.957999
1
0.024353 0.066085 0.023842 -0.01201

Size

Beyond CAPM Beta: Measures of Risk in Portfolio Risk-Return Analysis

EXHIBIT 2C
Cross Section Analysis Correlation Matrix- All Companies

Mean ReturnVariance
Mean Return
1
Variance
0.018562
1
SD
0.058522 0.975768
SSD-Rf
0.128127 0.829202
SSD-Rm
0.123282 0.850023
Skew
-0.48939 0.586217
Kurt
0.341356 0.638051
Co-Skew
-0.06792 -0.0576
Beta
-0.42324 0.539625
Residual
-0.0868 -0.17531
D Beta1
-0.40012 0.283224
D Beta2
-0.31263 0.486956
Size
-0.17538 0.282523

SD

SSD-Rf SSD-Rm Skew

1
0.829198
0.847853
0.530981
0.623257
-0.0303
0.582013
-0.21832
0.341013
0.528142
0.244233

1
0.985989
0.467057
0.538776
-0.17363
0.498584
-0.22866
0.455445
0.490016
-0.09812

1
0.491947
0.586409
-0.20497
0.492973
-0.21698
0.441298
0.489401
-0.05779

1
0.308351
-0.03183
0.545282
-0.29506
0.327802
0.522206
0.21001

Kurt

Co-Skew

Beta Residual D Beta1 D Beta2

1
-0.16098
0.065344
0.226795
-0.14581
-0.00619
0.123125

1
0.117473
-0.095016
-0.055896
0.1334172
0.4475754

1
-0.3273
1
0.882325 -0.28407
1
0.857194 -0.50931 0.809744
1
0.333193 -0.15692 -0.00768 0.100055

EXHIBIT 3A
Bivariate Regression- Mid Cap Stocks

var
sd
ssd-rf
ssd-rm
skew
kurt
coskew
beta
res
db1
db2
size

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c0
0.004598
0.014288
0.010979
0.011596
0.020211
0.01626
0.021522
0.014469
0.023799
0.018264
0.017021
0.009885

c1
0.117259
0.296838
0.082757
0.081909
0.003167
0.000616
0.000434
0.009641
-0.00107
0.006494
0.010221
0.000623

p value
0.179842
4.94E-05
0.027121
0.016557
5.69E-06
0.003096
9.6E-05
0.00341
1.58E-05
0.003767
0.000168
0.227811

p value
0.000362
0.000516
0.017863
0.016796
0.013991
0.120162
0.920599
0.035975
0.09842
0.385479
0.023425
0.140085

Size

Beyond CAPM Beta: Measures of Risk in Portfolio Risk-Return Analysis

EXHIBIT 3B
Bivariate Regression- Large Cap Stocks

c0
c1
p value p value
Variance -0.00242 0.237003 0.888417 0.065645
SD
0.012197 0.883547 0.207911 0.038214
SSD-Rf
-0.0065 0.245344 0.72901 0.060045
SSD-Rm
0.00178 0.207858 0.907886 0.067029
Skew
0.024622 0.012538 0.000365 0.014835
Kurt
0.024823 0.001818 0.001214 0.052669
Co-Skew 0.027784 19.90074 0.02894 0.646157
Beta
0.013589 0.018167 0.280889 0.127585
Residual 0.032966 0.231075 0.000229 0.645171
D Beta1 0.013625 0.017984 0.280622 0.128935
D Beta2 0.015495 0.01705 0.21171 0.152156
Size
0.062683 -0.00271 0.107566 0.399205
Note: BSE Data. E[R]: Mean returns; Beta: Systematic risk; SD: Total risk; Residual: Idiosyncratic risk;
Size: Log of average market cap; SSD-Rm: Semistandard deviation with respect to mean; SSD-Rf:
Semistandard deviation with respect to risk-free rate; D Beta1: Downside beta calculated using
observations when stock return falls(Down-i); D Beta2: Downside beta calculated using observations
when stock return and market return fall simultaneously(Down-iw); Skew: Skewness; Coskew:
Coskewness with world index using formula 2, Kurt: Kurtosis.

The second risk measure is total risk. Asset pricing theory says that only systematic risk, or the
part of variance that contributes to a well-diversified portfolios variance, should be important.
The regressions suggest that total variance can account for 11% of the variation in the mid cap
stock returns. Variance explains practically none of the large cap stock returns. A combined
analysis is heavily influenced by mid cap stock returns. The results for the third risk measure,
idiosyncratic risk, are similar to total risk.
The fourth risk measure is size. Size could be related to liquidity and the amount of information
available in the market, which are legitimate risk factors. We find that there is little relation

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Beyond CAPM Beta: Measures of Risk in Portfolio Risk-Return Analysis

between the average stock return and size i.e. size does not explain much of a variation in mean
stock returns.
The fifth through seventh measures are semistandard deviation measures. All are similar, and
from Exhibit 2 we know they are all highly correlated with total risk. We find that the
semistandard deviation measures account for a small part of the variation in the mid cap stock
returns (SSD-Rm: 16% and SSD-Rf: 11%) but not the large cap stock returns (nearly zero).
The sixth measures are downside betas. There is some relation between the downside betas and
the large cap stock returnsbut little relation with the mid cap stock returns.
For the analysis part, coskewness should also count, and skewness itself should not. This is
analogous to beta and variance. In the CAPM, it is only the beta that is rewarded, not the total
volatility. To be consistent, only the systematic part of skewness (the coskewness) should
command a reward. When we examine the skewness measures, we see a higher positive relation
with the average returns of mid cap stocks but less relation with large cap stock returns. This is
similar to what we see for total volatil ity. This explains that market for mid cap stocks are still
not that integrated and accessible as the large cap stocks are.
For the coskewness measures, in both developed and emerging markets, there is a positive
relation, suggesting that more positive coskewness gets a lower expected return which is what
the theory would suggest.
From an asset pricing perspective again, it is the contribution to kurtosis of a well-diversified
portfolio (the cokurtosis) that should be priced. We find a near zero relation between kurtosis and
returns in mid cap stocks but negative relation in large cap stocks.

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Beyond CAPM Beta: Measures of Risk in Portfolio Risk-Return Analysis

IV. SUMMARY
We have examined 12 measures of risk in 20 domestic listed stocks. Particular attention is paid
to a measure of downside implied by asset pricing theory: coskewness. This risk measure
captures the contribution that an asset makes to a well-diversified portfolios total skewness. A
negative coskewness would imply that adding an asset to the portfolio will decrease the
skewness of the portfolio.
Given that investors like positive not negative skewness, this asset would have to have a high
expected return to get investors to purchase it. Risk measures implied by asset pricing theory, in
particular world beta and coskewness, work reasonably well in capturing the cross-section of
average returns in world markets.
V. REFERNCES
Harvey, C.R. (2000). Drivers of Expected Returns in International Markets. Cambridge,
Massachusetts: National Bureau of Economic Research

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