Modeling risk and return relationship with reference to companies listed on the Zimbabwe Stock Exchange

Abstract

The relationship between risk and return is one of the most important concepts in investment theory. This relationship drives the theoretical foundation of many investment models such as the Capital Asset Pricing Model, which offers powerful and intuitively pleasing predictions about how to quantify risk. This study examines the relationship between risk and return for firms listed in the Zimbabwe Stock Exchange (ZSE). The study was carried out for the period February 2009 to February 2015 for 51 stocks listed on the ZSE. Combining Black, Jensen and Scholes with Markowitz methods of testing the CAPM, the whole period was tested and stocks’ betas were used instead of portfolio betas. Time series regression and mean variance analysis were used to test the relationship between expected returns and risk. The high beta-high returns relationship hypothesis was not fully exhibited by the ZSE stocks although there was a linear relationship between returns and beta coefficients. In addition, it was noted that non-systematic risk had no effect on expected returns. The researcher recommends that further studies considering factors that affect stock returns such as interest rates, exchange rates and inflation should be considered. These studies may be extended by employing advanced models like ARCH, GARCH, etc. Investors should make use of these models so that they will be able to understand risks and return associated with their investments.