Empirical test of the predictive power of the capital asset pricing model on the European stock market

The purpose of this research is to examine the predictive power of the capital asset pricing model in the European stock market. The research follows the method used by Fama & MacBeth (1973) for the empirical analysis which tests stock returns on the S&P Euro index for the time-period 1998-2015. Betas are estimated for individual stocks and portfolios are then formed based on the ranked betas. From there, portfolio betas are estimated and regressed against actual portfolio returns to see if there exists a positive linear relationship between beta and average return. The results obtained from this research suggest that the predictive power of the capital asset pricing model is quite poor since the model failed to give significant positive results neither for the overall period nor any of the sub periods examined. Therefore, we cannot recommend the CAPM as a method for predicting stock returns