Journal of Management Research

Open Access Open Access  Restricted Access Subscription Access
Open Access Open Access Open Access  Restricted Access Restricted Access Subscription Access

A Comparative Assessment of Unconditional Multifactor Asset-pricing Models


Affiliations
1 Department of Humanities and Social Sciences IIT Kharagpur- 721 302, India
     

   Subscribe/Renew Journal


The basic objective of this paper is to evaluate three alternative unconditional multifactor models to explain the cross-sectional stock return behavior in the context of Indian stock market. Fama and French time series regression approach is applied to examine the impact of market risk premium, size, bookto- market equity, momentum, and liquidity as risk factors on stock return. The empirical results show that three factor proposed by Fama and French (1993) retain their significance to explain the crosssection of stock return for test asset portfolios constructed beyond size and book-to-market equity characteristics. This finding is also robust to the inclusion of momentum and liquidity factors in four and five-factor model specifications. However, inconsistent with prior literature, book-to-market equity fails to explain the average return in case of large stocks. In the case of four-factor model, we found that pricing evidence of momentum profits fades in case of winner stocks and momentum strategy retains its value only for the sell side transactions i.e., loser portfolios. When the tests allow for the inclusion of liquidity factor in an augmented four-factor model, the results suggest that liquidity is priced and explains a cross-sectional variation in stock returns. The findings suggest that given the multi-dimensional nature of risk the choice of a five-factor model is apparently persuasive for consideration in investment decisions.

Keywords

Risk Factor, Multi-factor Model, Liquidity Risk, Momentum Strategy, Stock Return
User
Notifications

  • Amihud, Y. (2002), Illiquidity and Stock Returns: Cross-section and Time-series Effects, Journal of Financial Markets, 5(1): 31–56.

  • Ansari, V. A. (2000), Capital Asset-pricing Model: Should We Stop Using It, Vikalpa, 25(1): 55–64.

  • Banz, R. W. (1981), The Relationship between Return and Market Value of Common Stocks, Journal of Financial Economics, 9(1): 3–18.

  • Barberis, N. Shleifer, A. and Vishny, R. (1998), A Model of Investor Sentiment, Journal of Financial Economics, 49(3): 307–343.

  • Basu, D. and Chawla, D. (2010), An Empirical Test of CAPM—the Case of Indian Stock market, Global Business Review, 11(2): 209–220.

  • Bekaert, G. and Harvey, R. C. (2003), Emerging Markets Finance, Journal of Empirical Finance, 10(1-2): 3–55.

  • Breeden, D. (1979), An Intertemporal Asset-pricing Model with Stochastic Consumption and Investment Opportunities, Journal of Financial Economics, 7(3): 265–296.

  • Brockman, P. and Chung, D. Y. (2002), Commonality in Liquidity: Evidence from an Order-driven Market Structure, Journal of Financial Research, 25(4): 521–539.

  • Campbell, J. Y. (2000), Asset-pricing at the Millennium, Journal of Finance, 55(4):1515-1567.

  • Chan, K. C. and Chen, N. (1991), Structural and Return Characteristics of Small and Large Firms, Journal of Finance, 46(4): 1467–1484.

  • Chan, L., Jagadeesh, N. and Lakonishok, J. (1996), Momentum Strategies, Journal of Finance, 51(5): 1681-1713.

  • Chan, W. H. and Faff, W. R. (2003), An Investigation into the Role of liquidity in Asset-pricing: Australian Evidence, Pacific-Basin Finance Journal, 11(5): 555–572.

  • Chen, X., Kim, K. A., Yao, T. and Yu, T. (2010), On the Predictability of Chinese Stock Return, Pacific-Basin Finance Journal, 18(4): 403–425.

  • Carhart, M. M. (1997), On Persistence in Mutual Fund Performance. Journal of Finance, 52(1): 57–82.

  • Chui, C. W. A. and Wei, K. C. J. (1998), Book-to-market, Firm Size, and the Turn of the Year Effect: Evidence from Pacific-Basin Emerging Markets, Pacific-Basin Finance Journal, 6(3-4): 275–293.

  • Classens, S., Dasgupta, S. and Glen, J. (1995), Return Behaviour in Emerging Stock Markets, World Bank Economic Review, 9(1): 131–151.

  • Classens, S., Dasgupta, S. and Glen, J. (1998), The Cross section of Stock Returns: Evidence from the Emerging Markets, Emerging Market Quarterly, 9(1): 4–13.

  • Connor, G. and Sehgal, S. (2003), Tests of the Fama and French Model in India, Decision, 30(2): 1–20.

  • Daniel, K., Hirshleifer, D. and Subrahmanyam, A. (1998), Investor Psychology and Security Market under and Overreactions, Journal of Finance, 53(6): 1839-1885.

  • Dhankar, R. S. and Singh, R. (2005), Arbitrage Pricing Theory and the Capital Asset-pricing Model: Evidence from the Indian Stock Market, Journal of Financial Management and Analysis, 18(1): 14–27.

  • Dimson, E. and Mussavian, M. (1999), Three Centuries of Asset-pricing, Journal of Banking and Finance , 23(12): 1745–1769.

  • Fama, E. F. and MacBeth, J. (1973), Risk Return and Equilibrium: Empirical Tests, Journal of Political Economy, 81(3): 607–636.

  • Fama, E. F., and French, K. R. (1992), The Cross-section of Expected Stock Returns, Journal of Finance, 47(2): 427–465.

  • Fama, E. F. and French, K. R. (1993), Common Risk Factors in the Returns on Stocks and Bonds, Journal of Financial Economics, 33(1): 3–56.

  • Fama, E. F. and French, K. R. (1996), Multifactor Explanations of Asset-pricing Anomalies, Journal of Finance, 51(1): 55–84.

  • Fama, E. F. and French, K. R. (1998), Value Versus Growth: the International Evidence, The Journal of Finance, 53(6): 1975–1999.

  • Fama, E. F. and French, K. R. (2004), The Capital Asset-pricing Model: Theory and Evidence, Journal of Economic Perspectives, 18(1): 25–46.

  • Gischolar_main, C. and Verschoor, W. F. C. (2002), Further Evidence on Asian Stock Return Behavior, Emerging Markets Review, 3(2): 179–193.

  • Harvey, R. C. (1995), Predictable Risk and Return in Emerging Markets, The Review of Financial Studies, 8(3): 773–816.

  • Her, L. J. F., Masmoudi, T., and Suret, M. J. (2004), Evidence to Support the Four Factor Pricing Model from the Canadian Stock Market, Journal of International Financial Markets, 14(4): 313–328.

  • Ho, Y. W., Strange, R. and Piesse, J. (2000), CAPM Anomalies and the Pricing of Equity: Evidence from the Hong Kong Market, Applied Economics, 32(12): 1629–1636.

  • Hong, H., Lim, T. and Stein, J. C. (2000), Bad News Travels Slowly: Size, Analyst, Coverage, and the Profitability of Momentum Strategies, Journal of Finance, 55(1): 265-296.

  • Iqbal, J., Brooks, R., and Galagedera, U. A. D. (2010), Testing Conditional Asset-pricing Models: an Emerging Market Perspective, Journal of International Money and Finance, 29(5): 897–918.

  • Jegadeesh, N. and Titman, S. (1993), Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency, Journal of Finance, 48(1): 65–91.

  • Jegadeesh, N. and Titman, S. (2001), Profitability of Momentum Strategies: an Evaluation of Alternative Explanations, The Journal of Finance, 56(2):699–720.

  • Keene, A. M. and Peterson, R. D. (2007), The Importance of Liquidity as a Factor in Asset-pricing, Journal of Financial Research, 30(1): 91–109.

  • Kubota, K. and Takehara, H. (2003), Financial Sector Risk and the Stock Returns: Evidence from Tokyo Stock Exchange Firms, Asia-Pacific Financial Markets, 10(1): 1–28.

  • Lakonishok, J., Shleifer A. and Vishny, W. R. (1994), Contrarian Investment, Extrapolation, and Risk, Journal of Finance, 49(5): 1541-1578.

  • Lam, K. S. K. and Tam, K. H. L. (2011), Liquidity and Asset-pricing: Evidence from the Hong Kong Stock Market, Journal of Banking and Finance, 35(9): 2217–2230.

  • Lam, K. S. K. (2002), The Relationship Between Size, Book-to-market Equity Ratio, Earnings–price Ratio, and Return for the Hong Kong Stock Market, Global Finance Journal, 13(2): 163–179.

  • Lau, S. T., Lee, C. T. and McInish, T. H. (2002), Stock Returns and Beta, Firms Size, E/P, CF/P, Book-to-market, and Sales Growth: Evidence from Singapore and Malaysia, 12(3): 207–222.

  • Lewellen, J., Nagel, S., and Shanken, J. (2010), A Skeptical Appraisal of Asset-pricing Tests, Journal of Financial Economics, 96(2): 175–194.

  • Lintner, J. (1965), The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets, Review of Economics and Statistics, 47(1): 13–37.

  • Liu, W. (2006), A Liquidity Augmented Capital Asset-pricing Model, Journal of Financial Economics, 82(3): 631–671.

  • MacKinlay, A. C. (1995), Multifactor Models Do Not Explain Deviations from the CAPM, Journal of Financial Economics, 38(1): 3–28.

  • Madhusoodan, T. P. (1997), Risk and Return: A New Look at the Indian Stock Market, Finance India, 11(2): 285–304.

  • Markowitz, H. M. (1952), Portfolio Selection, Journal of Finance, 7(1): 77–91.

  • Marshall, B. R. and Young, M. R. (2003), Liquidity and Stock Returns in Pure Order Driven Markets: Evidence from the Australian Stock Market, International Review of Financial Analysis, 12(2): 173–188.

  • Martinez, M. A., Nieto, B., Rubio, G. and Tapia, M. (2005), Asset-pricing and Systematic Liquidity Risk: An Empirical Investigation of the Spanish Stock Market, International Review of Economic and Finance, 14(1): 81–103.

  • Misra, A. K. and Mahakud, J. (2009), Emerging Trends in Financial Markets Integration, International Journal of Emerging Markets, (3): 235–251.

  • Merton, R. C. (1973), An Intertemporal Capital Asset-pricing Model, Econometrica, 41(5): 867–887.

  • Narayan, K. P. and Zheng, X. (2010), Market Liquidity Risk Factor and Financial Market Anomalies: Evidence from the Chinese Stock Market, Pacific-Basin Finance Journal, 18(2): 509–520.

  • Pattengill, G. N., Sundaram, S. and Mathur, I. (1995), The Conditional Relation between Beta and Returns, Journal of Financial and Quantitative Analysis, 30(1): 101–116.

  • Ross, S. A. (1976), The Arbitrage Theory of Capital Asset-pricing, Journal of Economic Theory, 13(3): 341–360.

  • Rosenberg, B., Reid, K. and Lanstein, R. (1985), Persuasive Evidence on Market Inefficiency, Journal of Portfolio Management, 11(2): 9–17.

  • Rouwenhorst, K. G. (1998), International Momentum Strategies, Journal of Finance, 53(1): 267–284.

  • Rouwenhorst, K. G. (1999), Local Return Factors and Turnover in Emerging Stock Markets, Journal of Finance, 54(4):1439–1464.

  • Sehgal, S. (1997), An Empirical Testing of Three Parameter Capital Asset-pricing Model in India, Finance India, 11(4): 424–442.

  • Sehgal, S. and Jain, S. (2011), Short-term Momentum Patterns in Stock and Sectoral Returns: Evidence from India, Journal of Advances in Management Research, 8(1): 99–122.

  • Sehgal, S. and Balakrishnan, I. (2002), Contrarian and Momentum Strategies in the Indian Capital Market, Vikalpa, 27(1): 13–19.

  • Sharpe, W. F. (1964), Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk, Journal of Finance, 19(3): 425–442.

  • Shum, W. C. and Tang, G. Y. N. (2005), Common Risk Factors in Returns in Asian Emerging Stock Markets, International Business Review, 14(6): 695–717.

  • Srinivasan, S (1988), Testing of Capital Asset-pricing Model in Indian Environment, Decision, 15(1): 51–59.

  • Subrahmanyam, A. (2010), The Cross-section of Expected Stock Returns: What Have We Learnt from the Past Twenty-five Years of Research?, European Financial Management, 16(1): 27–42.

  • Verma, R. and Verma, P. (2009). Are Survey Forecasts of Individual and Institutional Investor Sentiments Rational?, International Review of Financial Analysis, 17(5): 1139–1155.

  • Vipul (1998), CAPM: Does it Help in Indian Market? Finance India, 12(1): 1–19.


Abstract Views: 741

PDF Views: 1




  • A Comparative Assessment of Unconditional Multifactor Asset-pricing Models

Abstract Views: 741  |  PDF Views: 1

Authors

Saumya Ranjan Dash
Department of Humanities and Social Sciences IIT Kharagpur- 721 302, India
Jitendra Mahakud
Department of Humanities and Social Sciences IIT Kharagpur- 721 302, India

Abstract


The basic objective of this paper is to evaluate three alternative unconditional multifactor models to explain the cross-sectional stock return behavior in the context of Indian stock market. Fama and French time series regression approach is applied to examine the impact of market risk premium, size, bookto- market equity, momentum, and liquidity as risk factors on stock return. The empirical results show that three factor proposed by Fama and French (1993) retain their significance to explain the crosssection of stock return for test asset portfolios constructed beyond size and book-to-market equity characteristics. This finding is also robust to the inclusion of momentum and liquidity factors in four and five-factor model specifications. However, inconsistent with prior literature, book-to-market equity fails to explain the average return in case of large stocks. In the case of four-factor model, we found that pricing evidence of momentum profits fades in case of winner stocks and momentum strategy retains its value only for the sell side transactions i.e., loser portfolios. When the tests allow for the inclusion of liquidity factor in an augmented four-factor model, the results suggest that liquidity is priced and explains a cross-sectional variation in stock returns. The findings suggest that given the multi-dimensional nature of risk the choice of a five-factor model is apparently persuasive for consideration in investment decisions.

Keywords


Risk Factor, Multi-factor Model, Liquidity Risk, Momentum Strategy, Stock Return

References