The paper develops a structural model, which shows that stock market returns and the risk-free rate are interdependent. It builds in macroeconomic and other structural features of an economy, which are referred to quite frequently as affecting the share price movements. This interdependence is estimated. Given the above interdependence that is derived from the model, the study also examines the causality between the above two variables in terms of a Granger test and a Sims test. The study then suggests that instead of using exogenous values of stock market returns and the risk-free rate for deriving the desired rate of return for individual stocks as per Capital Asset Pricing Model (CAPM), one should use the estimated values of these variables from the reduced form equations derived from the model. This is tested with data of individual companies.

The literature on prediction of share price movements is quite vast and it has been the focus of academicians, brokers, brokerage houses, investment bankers, treasury personnel, researchers, and common households.1 There are fundamentalists who believe that it is the performance indicators that drive share prices of companies. There are technical analysts who only look at patterns in historic price movements and believe that market price discounts everything and history repeats itself. If people genuinely believed that share prices cannot be predicted at all, then large multinational fund managers and investment bankers would have found it difficult to survive (Murphy, 1986). However, there is no specific method by which movement of share prices can be predicted with certainty.

Even a probabilistic approach may not hold good. It is indeed random and is the basic contention of the Efficient Market Hypothesis (Fama, 1970). Researchers, however, never give up hope and keep on trying novel methods for prediction. Sophisticated methods are used to analyze the data and generate insights.2 Besides trying to predict the movement of share prices, the literature has developed various indicators and structures, which have formed the basis of valuation, ex ante.3 That is, instead of analyzing price movements, it has provided methods to judge whether market prices reflect true value. These are important for making investment decisions, formergers and acquisitions, for portfolio valuation, and for measurement of risk, which is essential for risk management. This paper deals with one such structure that is provided by the Capital Asset Pricing Model (CAPM).

IUP Journal of Applied Finance, Structural Approach to Stock Market Returns, Capital Asset Pricing Model , CAPM, Fundamentalists, Technical analysts, macroeconomic System, Bombay stock exchange, BSE, Foreign Institutional Investor, FII, Gross domestic products, GDP, HDFC Bank , Infosys.