Arbitrage pricing theory: Evidence from an emerging stock market

Abstract

Employing the data for the period before the Asian Financial Crisis 1997-1998, between Jan 1987 and Dec 1996 under the light of the methodology proposed by Fama and McBeth (1973), the research investigates the relationship between the stock returns in the Stock Exchange of Thailand and some economic fundamentals including changes in exchange rates, industrial production growth rates, unexpected changes in inflation, changes in the current account balance, differences between domestic interest rates and international interest rates, changes in domestic interest rate.

The test’s results show that, within the scope of the methodology and data employed, the Arbitrage Pricing Theory (APT) does hold in the very emerging stock market of Thailand, while the CAPM (Capital Asset Pricing Model) fails to do so. While changes in exchange rates consistently explain the stock returns, there is one chance the exchange rates and the industrial growth rates together systematically affect the stock returns. The negative risk premiums associated with these factors shows investors in the SET are risk averse and tend to hedge against risks of changes in fundamentals. This research is an important contribution to the study of an emerging market stock price movements, which provides a base line for comparing with stock market price behaviours after the devastating crisis in Thailand in 1997-1998.