Testing the capital asset pricing model in İstanbul Stock Exchange

As it is known, risk and rate of return are the major factors that affect the investment decisions of investors. CAPM establish a concrete relationship between these two factors. Defined as ?a model that determine the expected return of a security of which the risk in the market is known? in short, CAPM reveals the underpriced or overpriced securities in the market.In this study, the validity of CAPM in the context of ISE is tested. The following four hypotheses are tested in accordance with this purpose. 1) Risk-Return relationship is linear. 2) The only measurement of the financial asset risk is Beta (ß). 3) There is a positive correlation between Beta and return. 4) CAPM is valid in ISE and market-effective.The data between the years January 2002 / September 2007 are used to test the hypotheses. These data consist of the monthly returns of the ISE-100 index, the risk-free interest rate and 84 shares which take part in the ISE-100 index.Two analyses are employed in order to test the validity of CAPM in ISE. The first analysis is the single independent variable regression analysis which puts forward the relationship between the market return and the share return and the direction of this relationship. The ß coefficients, obtained as a result of this analysis, are found significant. This situation shows that the changes in the share prices could be estimated by the changes in the market.Secondly, the panel data analysis test the hypotheses by investigating the relationship between the risk and return. The coefficients are found insignificant. As a result, first and second hypotheses of the study are accepted, while the third and fourth hypotheses are rejected. These results show that CAPM is not valid in ISE. That is, the investors in ISE do not rationally value the risk and return. Consequently, this situation has a negative effect on the investors.The possible reasons of this situation include the volatility of foreign capital, limited information flow towards the investors and the lack of professional investors in the market. From this point of view, the study reveals pretty important findings that should be considered for the economy of the country.