Abstract
Abstract This study aims to investigate whether investment and profitability are priced and if they partially explain the variations of stock returns in the Brazilian stock market, according to the Fama and French's (2015) five-factor model. By using time series and cross-section regression, we found that book-to-market, momentum and liquidity are associated with stock returns whereas investment and profitability were not significant. We also found that there is no investment premium in Brazil. Therefore, motivated by the importance of B/M, momentum and liquidity to the Brazilian stock market, as well as by the poor performance of profitability and investment, we document that Keene and Peterson's (2007) five-factor model is superior to all other models, especially the five-factor model by Fama and French (2015).
Highlights
Various models have been developed in search of factors that could improve the explanatory power of the Capital Asset Pricing model (CAPM), as well as capture anomalies in asset pricing. Fama and French (1993) developed the three-factor model, namely market – according to the CAPM – firm size and book-to-market ratio (B/M). Carhart (1997) identified the momentum factor and realised that the three-factor model and the CAPM were unable to explain it (Fama & French, 2004)
To achieve this objective we took the following steps: inquire if investment and profitability effects exist in the Brazilian stock market; investigate if investment and profitability must be added to asset pricing models as predictive variables of stock returns, after controlling the effect of other risk factors present in the literature; and, compare the performance of multi-factor models, as well as the impact of including profitability and investment factors on the performance of said models
By the end of June of each year t, stocks were arranged in ascending order according to the variable of interest
Summary
Various models have been developed in search of factors that could improve the explanatory power of the Capital Asset Pricing model (CAPM), as well as capture anomalies in asset pricing. Fama and French (1993) developed the three-factor model, namely market – according to the CAPM – firm size and book-to-market ratio (B/M). Carhart (1997) identified the momentum factor and realised that the three-factor model and the CAPM were unable to explain it (Fama & French, 2004). Fama and French (1993) developed the three-factor model, namely market – according to the CAPM – firm size and book-to-market ratio (B/M). Carhart (1997) identified the momentum factor and realised that the three-factor model and the CAPM were unable to explain it (Fama & French, 2004). Keene and Peterson (2007) analysed the importance of liquidity as a risk factor in asset pricing models, and added it to Carhart’s (1997) fourfactor model, concluding that liquidity is priced and explains part of stock return variations, improving the model’s explanatory power. Chen et al (2010) proposed an alternative three-factor model composed by market, profitability and investment risk factors
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