Revisiting the Empirical Challenges to the CAPM: A Study of the NSE During and Post COVID-19

This paper investigates the empirical validity of the Capital Asset Pricing Model (CAPM) on the NIFTY 50 Index during two distinct subperiods: the COVID-19 period (January 2020 to April 2023) and the post-COVID period (May 2023 to June 2024).

The study employs Lintner’s (1965) methodology, conducting cross-sectional regressions for each subperiod. The relationship between average returns, systematic risk (beta), and the variance of residuals is analyzed. Statistical signicance is determined using p-values, and the explanatory power of the model is assessed through R-squared values.

During the COVID-19 period, a significant negative relationship between average return and systematic risk is found, contrary to CAPM predictions. A positive and significant relationship between average return and the variance of residuals is also observed. The model’s explanatory power is notable with an R-squared value of 0.469678. In the post-COVID period, the negative relationship between average return and systematic risk becomes statistically insignificant, and the explanatory power of the model decreases significantly (R-squared value of 0.15079). In both periods, the CAPM underestimates the risk-free rate, however, market risk premium prediction during the COVID is quite good, but not after COVID.

This study provides critical insights into the performance of the CAPM during periods of economic disruption and recovery in the Indian stock market, highlighting the model’s limitations and suggesting the need for reconsideration or modiation to better capture market realities.