paper on risk return of different capitalisaion

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A Study of Risk and Return of Different Capitalisation Stocks in different Phases of Stock Market during 2007-2009 in India

- Mrunal Chetan Joshi ([email protected])

Abstract

Stock Market is ever green field for Investment and good choice of investment provides very

lucrative scope. But it is very difficult to select companies for investment as there are number

of companies listed in different stock exchanges. In this paper I have tried to catagorise

different stocks on the basis of Market Capitalisation and study them on the basis of

performance of different Indices of Bombay Stock Exchange related to different Capitalisation

Stocks i.e. Sensex for Large Cap Stocks, Mid Cap Index for Mid Cap Stocks and Small Cap Index

for Small Cap Stocks. For my study I have used daily value of selected Indices from January 2007

to December 2009. In this study I have found that there is no major difference in risk and return

of different capitalisation stocks, but there is significant difference in risk and return of same

stocks in different phases of stock market i.e. Bearish Trend, Consolidation Period and Bullish

Trend.

Introduction

In today’s dynamic environment when environmental factors are continuously changing at

global level it is very important for all organizations and even Individuals to get adjusted with it.

All these dynamic factors are also responsible to affect Economic aspect of Nation,

Organizations and Individuals too. For individual it is very important to take Investment decision

for continuous rise in his Economical wealth. When one is investing his personal savings it is

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very important to consider inflation rate to measure the real rate of return1. There are number

of investment avenues to invest. Some of these investment avenues are Bank Deposits, Post

Office Schemes, Company FDs, PPF, Bonds, Equity shares, Mutual Funds, Real Estate, Precious

Metals etc.

Out of these entire alternatives equity share are representative of growth of different

Companies and Industries in Indian economy. Equity share are operated through primary

market (New Issue Market) and Secondary market (Stocks Exchanges). To invest in Equity share

Market there are number of companies, Mutual Funds and derivatives through which we can

invest, but investment decisions plays very important role. Kinds of shares in the stock market

have their various the bases like type of Business, Turnover and Value etc. Each types of share

do not perform in similar manner, specifically during different phases of Stock Market. One of

the important bases to categories shares is its Capitalisation.

Capitalisation

Capitalisation means total number of shares issued by company multiplied by share value.

There are mainly three kinds of Capitalisation Large Cap Stocks, Mid Cap Stocks and Small Cap

Stocks. One of the ways to determine this capitalisation is as follow. Generally the biggest

companies with a market capital of more than $10 billion are considered to be large cap stocks.

The range for determining the mid cap stocks is between $ 2 billion to $ 10 billion. Companies

that have a market capitalization of the less than $ 2 billion are grouped under the small cap

stocks. These capitalisations may vary from stock exchanges with in the same country or among

different countries’ stock exchanges.

Bombay Stock Exchange and its Indices

Bombay Stock Exchange (BSE) is the largest stock exchange in India in terms of highest number

of companies listed with the stock exchange. If you consider the market capitalization of the

companies listed with BSE even then the stock exchange is the largest in the country. BSE has

1 Real rate of return is equal to actual return minus inflation rate

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established number of indices, which indicates performance of overall stock market or specific

stocks related to those indices.

In 1986 BSE came out with Index called SENSEX – Sensitivity Index. SENSEX is a basket of 30

constituent stocks representing a sample of large, liquid and representative companies. The

base year of SENSEX is 1978-79 and the base value is 100. BSE introduced the new index series

called 'BSE MID-Cap' index and 'BSE Small-Cap' index to track the performance of companies

with relatively smaller market capitalization. Base year of these indices would be 2002-2003

and Base index value would be 1000 for each of these indices. These three indices’ daily value

has been used in my research work.

Return

Return is yield plus capital appreciation, if any. The difference between the purchase price and the sale

price is capital appreciation and yield is the interest or dividend divided by its purchase price. There are

two concepts of return one is actual return and other is expected return. Actual return can be calculated

only after realization of return. Expected return is average rate of return. In calculation of average rate

of return there are different concept like arithmetical mean and geographical mean. I have used

arithmetical mean. Calculation of arithmetical mean is as follow.

Expected return = arithmetical mean = 𝑥𝑖

𝑛

Where, 𝑥𝑖= summation of return (𝑥𝑖) of all individual period

𝑛 = number of observations for which return has been measured

Volatility/Risk

Risk is the potential that a chosen action or activity (including the choice of inaction) will lead to a loss

(an undesirable outcome). The notion implies that a choice having an influence on the outcome exists

(or existed). Potential losses themselves may also be called "risks".

In finance, risk is the probability that an investment's actual return will be different than expected. This

includes the possibility of losing some or all of the original investment. In a view advocated by

Damodaran, risk includes not only "downside risk" but also "upside risk" (returns that exceed

http://en.wikipedia.org/wiki/Finance

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expectations). Some regard a calculation of the standard deviation of the historical returns or average

returns of a specific investment.

Risk or volatility can be measured through standard deviation or co-efficient of variance. When

observations are in absolute term standard deviation is not much useful, than co-efficient of variance

should be used. In this research observation is daily return percentage hence standard deviation is used

to measure risk or volatility of return. Formula for standard deviation is

Literature Review

Schwert (1988) has also used standard deviation to measure risk. He had shown that the

standard deviation of both stock returns and industrial production growth are higher during

recessions than during expansions.

Schwert William G. (1990) has used daily return for his study. He had focused on the effect of

the 20 percent drop in stock prices on the volatility of stock market return. He had analysed the

behavior of daily returns before and after the 1987 crash was unusual relative to the experience

of over 100 years of daily data. While the 1987 crash was the largest one day percentage

change in prices in over 29000 observations, it was unusual in that stock market volatility

returned to low pre-crash levels quickly.

Ahmed Gauher and Syed Abdul Malik (2009), he had stated in his study that according to the

Indian establishments, India is not going to be much touched by the crisis if growth rate of

some 8 to 9 percent is going to hold good. But according to the first or preliminary symptoms,

the Indian Economy is also going to be hit by the crisis, as already there is a crisis of liquidity in

the economy and the estimates of the growth rates are also being lowered.

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Kawai (2008), Sub-prime story: Bubble burst in 2008, collaps of the financial system of US,

affected global level.

Ravishankar B. and Mahesh Rajgopal (2009), has descibed several stages of financial crises in

US in following way:

1. Initial subprime crisis (June/July 2007)

2. Spillovers into other credit markets (July/August 2007)

3. Liquidity squeeze and forced reinter-mediation (August 2007)

4. Broad-based financial sector strain (Sept/Nov 2007)

5. Growth fears and dysfunctional markets (Jan/Feb 2008)

6. Continued deleveraging and deteriorating credit cycle (March-Sep. 2008)

7. Collapse of Investments Banks such as Merril Lynch etc.

The BSE Sensex has continued to bleed more out of panic and psychological reasons than for

others. In last few weeks (3-4) his study period BSE Sensex fell by almost 15%. It is also due to

shortage and dries up of capital from FII and FDI. I have also selected same period for my study.

Sandeep Kumar and Sweta Bakshi (2009), 1.3% industrial growth is the lowest IIP (Index of

Industrial Production) data ever registered since last ten years. April-august growth is 4.9%

which also lowest for the first five months of the financial year in 14 year period except 1998

and 2001. The Industrial growth in August of 2008 plummeted to mere 1.3% compared to

same month in 2007. This industrial slow down affected transport service too. Global recession

will also lead to less tourists coming to India. That will negatively affect tours and travels

industry. The global recession affected IT, automobile industry and export oriented firms

adversely.

Louis K.C.Chan, Jason Karceski and Josef Lakonishok (2000), Operating performance of large cap

growth stocks in last few years can not have been trigger for their huge stock returns. Over the

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period 1996-98 period, large-cap growth stock earned a return of 34% a year, but their

operating performance for this period was not outstanding when compared with the past. The

growth rate (in terms of sales) for the three years was 6% a year but he average for these

companies was 10.3% for the entire sample period. It is not easy to continuously perform at

higher rate or increasing rate. The same thing happens with large-cap companies. They also

observed that Small-cap stocks have historically outperformed large-cap stocks and value

stocks have had higher return than growth stocks. For the selected period they have found that

small-cap stocks did well and small-cap value stocks did particularly well.

Poshakwale, S., & Theobald, M. (2004, May 8), The lead/lag relationship between portfolios

comprising large and small cap firms is analytically derived in terms of their speeds of

adjustment and degrees of thin trading. Using a number of Indian equity index series that differ

in their market capitalization characteristics, large cap indices are found to lead small cap

indices and to have higher speeds of adjustment towards intrinsic values.

Objectives

Primary Objectives

To know the risk and return of different capitalisation Stocks during different phases of

Indian stock market in India.

Secondary Objectives:

To study the movement of different indices of different capitalisation for the selected

period.

To know risk and return related to different stocks of different capitalisation during

different phases of stock market

To analyze volatility of different capitalisation stocks during different phases of stock

market in India

To identify most risky capitalisation stock with its return relationship

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Research Methodology

Type of Research:

For my study I have applied Descriptive Research design, which helped me describing the fact

on the basis of my analysis of secondary data. I have collected daily price data of different

Indices of different Capitalisation of BSE i.e. Sensex, Mid-Cap Index and Small-Cap Index.

Analysis have been done on the basis of daily return, which is calculated on the basis of daily

price data.

Population:

For this study my population includes all different stocks of different capitalisations and value

of their daily prices which determines risk and return related to them from the date of their

listing in Stock Exchanges in India.

Sampling and Sample Frame:

For this study I have applied Judgmental Sampling. For study of different Capitalisation stock I

have selected different indices of Bombay Stock Exchange i.e. Sensex, Mid-Cap Index and Small-

Cap Index which may properly represents them. I have observed the period from 1st January

2007 to 31st December 2009 i.e. two year daily value of selected indices. This period represents

different phases of Stock Market viz. Bearish Trend, Consolidation Period and Bullish Trend.

Sample:

After determining two years period and careful study of chart of daily values of different indices

i.e. Small-Cap, Mid-Cap and Sensex, I had selected a particular period from 10th Sept 2008 to

19th May 2009, from the observed the period (1st January 2007 to 30 November 2009) for detail

analysis on the basis of certain concepts of technical analysis.

Data Collection

Secondary data of daily prices of different capitalisation stocks are collected from internet,

website www.bseindia.com.

Data Analysis

First of all I have used Technical analysis for the selection of data out of the Sample Frame. In

which support line and resistant line has been drawn on the basis of subjective analysis of trend

lines of selected Indices of different Capitalisation Stocks.

For the calculation of Return I have used Arithmetical Mean which represents expected return

and Risk is calculated on the basis of deviation from mean. Here standard deviation has been

used for calculation of risk.

http://www.bseindia.com/

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For study of significant difference in Return and Risk ANOVA has been used with the use of

statistical computer package SPSS (Statistical Package for Social Science).

Interpretation and Analysis of Data

For my study of performance of different Indices of different Capitalisation during different

phases of Stock Exchange, I have observed two years data of sensex, Mid-Cap and Small Cap

index of BSE. For two years time period I have selected time period from 1st January 2007 to 30

November 2009. I have collected daily value of selected indices representing different stocks of

different capitalisation. Than after I have calculated daily return percentage for all indices for

every day, as it is very difficult to work with absolute data. Following chart represents all those

values.

Figure: 1

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Out of selected period it has been observed that on 10th Sept 2008 (Line A in the Figure)

onward Bearish Trend has been started. We can observe that resistant line (Line 1,2 and 3 for

Mid Cap, Small Cap and Sensex respectively, in the Figure) has been cross in each capitalisation

and Bearish Trend continued up to 3rd Dec 2008 (Line B in Figure), after which we can observe

that again trend has established new support (not marked in the figure) below which it had

hardly move and remain less fluctuated up to certain period of time i.e. 12th March 2009 (Line C

in Figure). After this Consolidation Period again all Indices have cross previous resistant line

which became Support Line (Line 1,2 and 3) from which Bullish Trend Started and market trend

moved up continuously with new support levels till 19th May 2009 (Line D in Figure).

Hence we can select this particular period from 10th Sept 2008 to 19th May 2009, from the

observed the period (1st January 2007 to 30 November 2009) for detail analysis, which also

properly represents different phases of Stock Market. With use of the technical analysis we can

divide selected period in basically three parts i.e. three different Phases: Bearish Trend,

Consolidation Period and Bullish Trend. As my objective is to study Stocks of Different

Capitalisation Stocks during different phases of Stock Market; collected data of different Indices

like Sensex, Mid-Cap Index and Small Cap index of Bombay Stock Exchange would be useful for

my study.

For analysis of collected data following Statistical Analysis has been done with the help of SPSS

software.

Univariate Analysis of Variance

Table: 1 Between-Subjects Factors

Value Label Number of Observations

Indices

1 Sensex Return 162

2 Mid-Cap Return 162

3 Small-Cap Return 162

Time Period 1 Bearish Trend 168

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2 Consolidation Period 192

3 Bullish Trend 126

From above table we can observe that total number of data for each Index for the selected

period is 162 working days return. For different phases like Bearish Trend, Consolidation Period

and Bearish Trend number of observations were 168, 192 and 126 respectively.

Descriptive Statistics

Table: 2 Dependent Variable: Return

Indices Time Period Mean Std. Deviation N

Sensex Return

Bearish Trend -.8017 4.88829 56

Consolidation Period -.0721 2.57563 64

Bullish Trend 1.4420 3.41796 42

Total .0683 3.80753 162

Mid-Cap Return

Bearish Trend -1.1671 5.07494 56


Bullish Trend 1.2346 2.15057 42

Total -.1333 3.47949 162

Small-Cap Return

Bearish Trend -1.3152 2.78056 56


Bullish Trend 1.2462 2.38170 42

Total -.2024 2.51745 162

Total

Bearish Trend -1.0947 4.35259 168


Bullish Trend 1.3076 2.68673 126

Total -.0892 3.30885 486

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For the selected period mean return and standard deviation for different indices during

different period and their total is calculated in above table. In the same manner during the

particular period what was descriptive statistics is given at last part of the table.

From above statistics we can say that Bearish period is most risky period as the standard

deviation of it is maximum i.e. 4.35 compare to all other period i.e. 2.08 and 2.68 for

Consolidation Period and Bullish Trend respectively.

In similar manner we can also observe that the risk in Large Cap Indices (Sensex) is highest in all

different phases than Mid Cap and Small Cap Indices, but at the same time return is also highest

in Sensex compare to other indices during all the phases of Stock Market.

Tests of Between-Subjects Effects

Table: 3 Dependent Variable: Return

Source Type III Sum of Squares df Mean Square F Sig.

Corrected Model 425.259(a) 8 53.157 5.191 .000

Intercept .396 1 .396 .039 .844

Indices 6.378 2 3.189 .311 .733

Time Period 415.925 2 207.963 20.308 .000

Indices * Time Period 2.926 4 .731 .071 .991

Error 4884.750 477 10.241

Total 5313.872 486

Corrected Total 5310.009 485

a R Squared = .080 (Adjusted R Squared = .065)

Above table represents two-way ANOVA table. The F-ratio for Indices 0.311 and p-value is 0.733

which is not less than 0.05. The F-ratio for Time Period is 20.308 and p-value less than 0.5.

Therefore it can be said that the effect of Indices is not significant whereas effect of Time

Period is significant. The F-ratio of Indices by Time Period interaction is 0.071 and associated p-

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value is very high i.e. 0.991 which is not less than 0.05. Thus, the Indices by Time Period

interaction effect (Indices * Time Period) is also not statistically significant.

Above table is very important for analysing the variation in return of different indices due to

type of the stock or due to time period or due to combine effect. F statistics and significant

value assist in determining the significant effect on variation in return. Out of above table we

can derive conclusion that there is no significant difference due to Indices or combine effect of

Indices and Time Period, but of course there is significant effect of time period as separate

variable. There is significant difference in different time period return divided in three parts. For

the detail analysis post hoc analysis is very useful to identify detailed significant difference in

return of different indices and during different time period.

Estimated Marginal Means

Table: 4 Grand Mean

Dependent Variable: Return

Mean Std. Error

95% Confidence Interval

Lower Bound Upper Bound

0.028991 0.14741 -0.26066 0.318644

Table: 5 Indices


Indices Mean

Std.

Error



Sensex Return 0.18942 0.255321 -0.31227 0.691112

Mid Cap Return -0.01965 0.255321 -0.52135 0.482039

Small Cap Return -0.08279 0.255321 -0.58448 0.418901

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Table: 6 Time Period


Recession

Mean

Std.

Error


Lower

Bound

Upper

Bound

Before Recession -1.095 .247 -1.580 -.610

During Recession -.126 .231 -.580 .328

After Recession 1.308 .285 .747 1.868

Table: 7 Indices * Time Period


Indices

Recession

Mean

Std.

Error



Sensex Return

Before Recession -.802 .428 -1.642 .039


After Recession 1.442 .494 .472 2.412

Mid Cap Return



After Recession 1.235 .494 .264 2.205

Small Cap Return



After Recession 1.246 .494 .276 2.216

Post Hoc Tests

The table – Multiple comparisons show the difference in Mean and associated significance level

between each pair of groups.

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Indices: Multiple Comparisons


Table: 8 Scheffe

(I) Indices

(J) Indices

Mean

Differenc

e (I-J)

Std.

Error Sig.


Upper

Bound

Lower

Bound

Sensex Return

Mid Cap Return .2016 .35557 .852 -.6715 1.0747

Small Cap Return .2707 .35557 .749 -.6024 1.1437

Mid Cap Return

Sensex Return -.2016 .35557 .852 -1.0747 .6715

Small Cap Return .0691 .35557 .981 -.8040 .9422

Small Cap Return

Sensex Return -.2707 .35557 .749 -1.1437 .6024

Mid Cap Return -.0691 .35557 .981 -.9422 .8040

Based on observed means.

Homogeneous Subsets

Return

Table: 9 Scheffe

Indices N Subset

Small Cap Return 162 -.2024

Mid Cap Return 162 -.1333

Sensex Return 162 .0683

Sig. .749

Means for groups in homogeneous subsets are displayed. Based on Type III Sum of Squares The error term is Mean Square(Error) = 10.241. a Uses Harmonic Mean Sample Size = 162.000. b Alpha = .05.

It can be seen from above table of Indices (two rows) that the difference in mean return of

Sensex and Mid-Cap is 0.20158 with associated significance level 0.85159 which is greater than

0.05, which means that difference of 0.20158 return is not statistically significant. The second

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row shows the mean return difference between Sensex and Small Cap indices which 0.270667

with associated significance level 0.7485 which also greater than 0.05, which means that

difference of 0.270667 return is not statistically significant.

In third row, Mid-Cap return is compared with Sensex return and therefore the difference and

significant level will be same as that of first row. In forth row, Mid-Cap and Small Cap return is

compared. The difference in mean return is 0.069086 and associated significance level is

0.981301, which means that the difference in return in Indices does not differ significantly.

Each comparison appears twice, as each of the indices is compared with the remaining two

indices. The magnitude of difference and significance level remains the same, only sign changes

with change in the reference group. The reference group is denoted by ‘I’ and the other

categories are denoted by ‘J’.

The Homogeneous Subsets table created using Scheffe’s test show that Sensex, Mid-Cap and

Small Cap all indices are homogenous set. Here, N represents the sample size for each group.

Time Period

Multiple Comparisons


Table: 10 Scheffe

(I) Recession

(J) Recession

Mean

Difference

(I-J)

Std.

Error Sig.


Upper

Bound

Lower

Bound

Before Recession

During Recession -.9687(*) .33807 .017 -1.7988 -.1386

After Recession -2.4022(*) .37713 .000 -3.3283 -1.4762

During Recession

Before Recession .9687(*) .33807 .017 .1386 1.7988

After Recession -1.4335(*) .36689 .001 -2.3344 -.5327

After Recession

Before Recession 2.4022(*) .37713 .000 1.4762 3.3283

During Recession 1.4335(*) .36689 .001 .5327 2.3344

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Based on observed means.

* The mean difference is significant at the .05 level.

Homogeneous Subsets

Return

Table: 11 Scheffe

Recession N Subset

1 2 3

Before Recession 168 -1.0947

During Recession 192 -.1260

After Recession 126 1.3076

Sig. 1.000 1.000 1.000

Means for groups in homogeneous subsets are displayed.

Based on Type III Sum of Squares

The error term is Mean Square(Error) = 10.241.

a Uses Harmonic Mean Sample Size = 157.091.

b The group sizes are unequal. The harmonic mean of the group sizes is used. Type I error

levels are not guaranteed.

c Alpha = .05.

It can be seen from above table of Time Period (two rows) that the difference in mean return of

Bearish Trend and Consolidation Period is -0.9687 with associated significance level 0.017074

which is less than 0.05, which means that difference of -0.9687 return is statistically significant.

The second row shows the mean return difference between Bearish Trend and Bullish Trend

Time Period which -2.40224 with associated significance level 0.000 which also less than 0.05,

which means that difference of -2.40224 return is statistically significant.

In third row, Consolidation Period return is compared with Bearish Trend return and therefore

the difference and significant level will be same as that of first row. In forth row, Consolidation

Period and Bullish Trend return is compared. The difference in mean return is -1.4335 and

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associated significance level is 0.001, which means that the difference in return in Time Period

differs significantly.

Each comparison appears twice, as each of the Time Period is compared with the remaining

two Time Period. The magnitude of difference and significance level remains the same, only

sign changes with change in the reference group. The reference group is denoted by ‘I’ and the

other categories are denoted by ‘J’.

The Homogeneous Subsets table created using Scheffe’s test show that Bearish Trend,

Consolidation Period and Bullish Trend all Time Period are different set. Here, N represents the

sample size for each group.

Figure: 2

After RecessionConsolidation Period Bearish Trend

Esti

mat

ed

Mar

gin

al M

ean

s

1.50

1.00

0.50

0.00

-0.50

-1.00

-1.50

Smlcap Return

Midcap Return

Sensex Return

Indices

Estimated Marginal Means of Return

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Conclusion

From above study I can conclude that when risk will be more chances of making return will be

more. Here if we observe performance of different Capitalisation Indices; they do not perform

very differently in any of the phase of stock market, but even the same Indices performs

differently in different phases of stock market. Thus, I can say that types of capitalisation do not

make much difference in Risk and Return involve with investment but the timing plays very

important role in investment decision.

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