Conflicting Effects of Market Volatility on the Power of Two-Pass OLS Test of the CAPM: A Simulation Analysis

Abstract

The study focuses on widely used CAPM test, the two-pass test. It is argued and shown by a simulation that power of the test does not continuously decrease when the standard deviation of market premium increases as existing literature reports. Rather it is peaked at the middle indicating the standard deviation of market premium has negative as well as positive effects on the power. The implication of this finding is that rejecting the CAPM is highly possible in lesser volatile market as in a highly volatile market even when the CAPM exists in those markets.DOI: http://dx.doi.org/10.4038/kjm.v2i1.6542 Kelaniya Journal of Management Vol.2(1) 2013:18-38

Keywords

• Two-pass OLS regression
• Power determinants
• Market volatility