Abstract

The paper investigates the link between systematic risk and corporate business performance, represented mainly by the degree of operative and financial leverage. Although theoretical contributions link the value of the common stock to corporate performance, CAPM does not identify a satisfactory relation between the latter and ß, setting aside the relation to the corporate capital structure. A detailed analysis of CAPM highlights two relevant anomalies: short sales and R-squared low values explaining the fundamental relation between stock and stock market excess return. Using an alternative approach, we highlight how CAPM, on one side, can be an incomplete theory to explain the stock returns and, on the other side, that the portfolio risk could be equivalent to the underlying corporate businesses portfolio, filtered by the feedback effect of the stock market. The empirical evidence descending from the analysis of several portfolios with an increasing number of stocks belonging to the S&P 500 Index reveals that the optimisation process leads to progressively higher ß paired with a simultaneous R-squared deterioration; furthermore, ß appears subject to sudden oscillations. Overall, ß does not adequately represent the relation between stock risk and return. The integration of the joint performance of the stock market and corporate business in an MLR relation leads to a clear improvement in R-squared thanks to the surfacing of the correlation between these two explanatory variables, a condition entirely ignored by CAPM.

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