International Journal of Economics and Finance; Vol. 7, No. 7; 2015 ISSN 1916-971X E-ISSN 1916-9728 Published by Canadian Center of Science and Education 163 Beta Estimation and Thin Trading: Evidence from Bahrain Bourse Jasim Al-Ajmi 1 1 Department of Economics and Finance, College of Business Administration, University of Bahrain, Bahrain Correspondence: Jasim Al-Ajmi, Department of Economics and Finance, College of Business Administration, University of Bahrain, P. O. Box 32038, Sakheer, Bahrain. Tel: 973-3944-4284. E-mail: jasimalajmi@gmail.com Received: March 16, 2015 Accepted: April 27, 2015 Online Published: June 25, 2015 doi:10.5539/ijef.v7n7p163 URL: http://dx.doi.org/10.5539/ijef.v7n7p163 Abstract This study is provides some guidelines indicating how to estimate beta (systematic risk) for companies listed on the Bahrain Bourse. Several estimation techniques were used to estimate beta. The methodology suggested by Fama and MacBeth (1973) for testing the CAPM based on cross-section analysis is used. Several problems are identified which require attention when estimating beta of companies listed on the Bahrain Stock Exchange. These are the intervals of rate return, the length of the estimation period, the best procedure to control for thin trading, the market index that should be used to estimate beta and the stability of beta estimates over time. The present study uses rates of return for different intervals (daily, weekly and monthly) for the period between January 2007 and December 2011 for 39 companies to test a number of hypotheses. The results of various tests show the following: 1) the estimated betas are insensitive to the length of period used; 2) the impact of return intervals on estimated betas is not significant ; 3) betas estimated using the All-Share Index and the MCSI are not significantly different from each other; 4) the estimated betas based on weekly data do not depend on the day of the week chosen to calculate the rate of returns; and 5) the impact of thin trading on beta depends on the method used to account for thin trading. Keywords: Bahrain, beta, emerging markets, systematic risk, Thin trading 1. Introduction The capital asset pricing model (CAPM) predicts that an asset’s expected and required rates of return are linear functions of its systematic (non-diversified) risk, measured by beta. This is because beta is the only measure of risk that explains the cross sectional variation of asset rates of return. Beta measures the risk associated with a particular asset in relation to the overall market. Since it was developed by Sharpe (1964), Lintner (1965) and Black (1972) (SLB hereafter), CAPM underwent extensive investigations to determine its validity and the usefulness for determining the rates of return of securities and portfolios. Those investigations yielded mixed results. The results of a number of empirical studies, such as Reinganum (1981), Lakonishok and Shapiro (1986), Fama and French (1992), Jagadeesh (1992), Yang and Donghui (2007), Nikolaos (2009) and Zubairi and Farooq (2011), provide that the relationship between beta and expected rate of return is not always significant. Fama and French (2004) state that empirical work since the late 1970s has challenged the validity of the prediction made by CAPM. Specifically, evidence mounts that much of the variation in expected return is unrelated to market beta. However, Vosilov and Bergström (2010) report that beta is a proper predictor of rate of return. Despite the mixed research results, practitioners continue to use the model for portfolio construction, investment decisions and measuring asset rates of return and cost of capital. A survey of a thousand financial directors of American firms which is made on a regular basis by Duke University and CFO Magazine shows that in 2008 and 2009 nearly 75% of respondents used CAPM in the construction of asset valuations (Graham & Harvey, 2009). The present paper contributes to the literature on the subject as it represents a primary investigation in at least two respects. While there is substantial evidence about this relationship for developed countries, there is little evidence for developing economies with relatively immature stock markets and potentially unique transmission mechanism mediating real activities and monetary policies. Potential beneficiaries of the findings from this study include Bahrain Bourse, financial institutions operating in Bahrain and other countries, the Central Bank of Bahrain, students and the academic community.