Capital Asset Pricing Model and Arbitrage Pricing Theory in the Italian Stock Market: an Empirical Study

Abstract

The Italian stock market (ISM) has interesting characteristics. Over 40 per cent of the shares, in a sample of 30 shares, together with the Mibtel market index, are normally distributed. This suggests that the returns distribution of the ISM as a whole may be normal, in contrast to the findings of Mandelbrot (1963) and Fama (1965). Empirical tests in this study suggest that the relationships between b and return in the ISM over the period January 1990 to June 2001 is weak and the Capital Asset Pricing Model (CAPM) has poor overall explanatory power. The Arbitrage Pricing Theory (APT), which allows multiple sources of systematic risks to be taken into account, performs better than the CAPM, in all the tests considered. Shares and portfolios in the ISM seem to be significantly influenced by a number of systematic forces and their behaviour can be explained only through the combined explanatory power of several factors or macroeconomic variables. Factor analysis replaces the arbitrary and controversial search for factors of the APT by "trial and error" with a real systematic and scientific approach.