Testing the CAPM in Bosnia and Herzegovina with Continuously Compounded Returns

The capital markets of neighboring transitional Western Balkan countries have attracted a lot of interest from domestic and international investors in the last decade, who view them as an attractive alternative to investing in more developed markets. These markets are characterized by higher returns, and higher volatility of stock returns as compared to those of developed markets. The recent economic and financial crises devastated capital markets worldwide. The new Bosnian capital market faced its hardest times following the withdrawal of international investors.

The aim of this paper is to explore whether there is a standard relation between stock returns and market portfolio returns, as proposed by the Sharpe-Lintner Capital Asset Pricing Model (CAPM), in the stock market of Bosnia and Herzegovina. We tested the model hypotheses with a traditional two-stage regression procedure using the OLS method, using continuously compounded (logarithmic) returns on stocks. Our study indicates that despite the crisis the systematic risk measured by the beta coefficient is priced and that the beta premium is positive. Nevertheless, the Security Market Line (SML) intercepts the ordinate lower than the risk free rate of return. Other factors might also influence stock returns in this market.