Asset pricing models : an investigation into determining the value of JSE AltX exchange listed shares

Abstract

The establishment of the Altx exchange provided the opportunity for investors to invest in small high growth companies which sometimes provide spectacular returns. The firms listed on the Altx JSE exchange have provided exceptional returns in the South African market over the last few years and in March 2007 the price earnings ratio on the Altx exchange was 1.4 times that of the JSE main exchange. Investors wanting extraordinary gains would want to include these stocks in their portfolios, but a valid asset pricing model is needed for these assets to be considered for inclusion in a portfolio. Previous studies have shown that the traditional capital asset pricing model is difficult to apply to assets of this nature. Three widely. used models of increasing complexity are identified to be tested with securities listed on the AltX exchange. These models are the Capital Asset Pricing Model; the Fama-French Three Factor Model and the Arbitrage Pricing Theory. The predictive qualities, of all three models are evaluated using a Two Step Regression methodology. The first step entails a series of time series regressions that are used to determine the model factors. The predictive abilities of these factors in the models are evaluated using a second series of cross sectional regressions over all the companies. Yearly data from the period 2000-2007 is used in the empirical study. This is a very small amount of data and limits the applicability of the results obtained. None of the three models used passed all of the significance tests to show that their predictive qualities are valid. It does however seem from the R2 values that the Fama-French Three Factor Model and Arbitrage Pricing Theorem describe much more of the variation in the expected returns of Altx listed stocks. It is suggested that these results are confirmed in future studies using more data.