Introduction 8
Chapter 1. CAPM with nonmarketable assets 11
1.1 Overview of the traditional CAPM model 11
Overview of the model and its key assumptions 11
Effect of inflation 13
1.2 Empirical tests of SLM CAPM 13
Stationarity of P coefficients 14
CAPM tests based on the construction of the SML line 15
Current state of CAPM 16
1.3 CAPM with nonmarketable assets 17
1.4 Empirical tests of CAPM with nonmarketable assets 21
Fama, Schwert (1977) Human Capital and Capital Market Equilibrium 21
Jagannathan, Wang (1996) Conditional CAPM and Cross-Section of Expected Returns 22
Jagannathan et al (1996) CAPM with human capital: Evidence from Japan 24
Chapter 2. CAPM with nonmarketable assets in Russia 26
2.1 The data 26
Definitions 26
Summary statistics 28
2.2 Econometric approach 40
Econometric model 40
Test for statistical significance of results 42
2.3 Statement of the results 43
2.4 Interpretation of the results 45
2.5 Limitations 46
Ways to define human capital 46
Human capital as a proxy for nonmarketable assets 46
Company data 47
Conclusions 48
References
For the fund managers the decision to invest or not is usually based on such factors as expected return on the security and the risk of the unfavorable deviations. Currently, the Capital Asset Pricing Model is the most popular model among investors to calculate the returns on securities. According to CAPM, the total risk of a security can be broken down into systematic (undiversifiable) and asset-specific (diversifiable) risks. The model suggests that investors require premium only for systematic risk, since specific risk can be completely eliminated by diversification, and the systematic risk measure, в, depends on the covariation of asset returns with market returns. As any other financial theory, CAPM implies a number of assumptions:
• Investors are risk-averse maximizers of expected returns;
• All investors can give loans and borrow an unlimited amount of money at a certain risk-free interest rate;
• All investors have similar expectations;
• All assets are perfectly divisible and liquid;
• There are no transaction costs or taxes;
• All investors take price as an exogenously given value;
• The number of all financial assets is fixed and determined in advance;
• All investors have the same fixed holding period;
• All information is available to all investors at zero costs.
These assumptions, which are rather strict and unrealistic, have caused many doubts around the validity of the model. Vast amount of research has been done to prove insufficiency of CAPM - various authors claimed that actual returns differ significantly from those predicted by the Sharpe-Lintner-Mossin CAPM, and tried to improve the model by extending it through inclusion of new factors.
In this paper, the author pays special attention to the model developed by Mayers (1972), who challenged the assumption of marketability of all assets by introducing the effect of nonmarketable assets. Mayers examined the role of returns to human capital as a proxy for nonmarketable asset. Mayers’ extended model suggests that since any individual investor’s human capital is unique, the covariance between the market portfolio and payoffs to human capital will have an impact on the optimal weight of the market portfolio, therefore, the covariance explains why investors hold different portfolios in reality.
In this paper, the author has presented and empirically tested the Capital asset pricing model with nonmarketable assets, namely human capital. The postulated relation between risk and expected return is of the same linear form as that of the Sharpe-Lintner-Mossin model. Thus, the structure of asset prices remains essentially the same even when nonmarketable assets are included in the investor’s portfolio problem. However, the results differ from those of the SLM model in that the expanded measures of the firm’s systematic risk and the market risk include the risk attributable to the existence of nonmarketable assets.
The formulation of the modified model is identical to the missing assets formulation of the SLM model - that is, ignoring the existence of nonmarketable assets in the expanded model leads to the same form of misspecification of the measure of relative systematic risk as does excluding portions of the universe of marketable assets in the SLM model.
Contrary to the SLM model, the expanded model implies that not all maximizing investors hold the identical (except for scale) portfolio of marketable assets. It implies that each investor holds a portfolio of marketable assets that solves his personal (and possibly unique) portfolio problem and, therefore, allows investors to maintain unique portfolios.
Empirical analysis of the CAPM with nonmarketable assets has shown significant difference of the estimates of the models for Innovations sectors. The beta predicted by extended model is 9.2% higher than the SLM beta. Unfortunately, the research has failed to prove the validity of the model for other sectors of companies and for the market in general, which may be attributable to the limitations stated in the paper. These limitations include: 1) the quarrels about the way to define human capital, 2) the controversy of using human capital as a proxy, and 3) the imperfection of data on Russian stock market.
For further researches on the topic, one could consider extending the definition of human capital by including other payments such as corporate trainings, social package, workplace infrastructure maintenance and other factors that comprise costs of maintaining a unit of human capital in the working order.
Finally, other types of nonmarketable asset may be elaborated. At this point, the work of Alexander Bukhvalov (2008) could be considered. Specifically, Professor Bukhvalov has suggested M&A volumes as a proxy for nonmarketable asset.
