Testing for regime-switching CAPM on Zagreb Stock Exchange

The standard Capital Asset Pricing Model assumes that a linear relationship exists between the risk (beta) and the expected excess return of a stock. However, empirical findings have shown over the years that this relationship varies over time. Stock markets undergo phases of greater and smaller volatility in which beta varies accordingly (undergoes different regimes). Given that the Croatian capital market is still insufficiently investigated, the aim of this paper is to explore the possibility of a non-linear relationship between the stock risk and return. Linear and Markov-switching models (Hamilton 1989) are examined on the Zagreb Stock Exchange based on monthly data on 21 stocks, ranging from January 2005 to December 2013. In that way, investors can use the results based on the best model when making decisions about buying stocks. Since this is one of the first papers on regime-switching on the Croatian capital market, it will hopefully contribute to the existing literature on investing