Abstract
Asset pricing in its essence is a very controversial topic. Despite numerous research papers criticising traditional approaches, such as linear factor models, practitioners as well as academics repeatedly return to the milestone models such as the Capital Asset Pricing Model (CAPM), mainly due to their attractive simplicity. This article focuses on the risk-return relationship by comparing the power of traditional and alternative asset pricing models in explaining the cross-section of asset returns. The focus is on unconditional models, commonly used among investors and equity analysts. This paper is based on the research performed by Estrada in 2004 and it extends his approach by introducing the use of GMM. The results suggest that for Emerging markets' investors should give preference to total risk measures over systematic risk measures. Within the category of systematic risk measures, downside beta proved its superiority to traditional CAPM beta. The results can be attributed to delayed integration process, partially justified by the lower FDI and portfolio investments into Emerging markets.
Highlights
Asset pricing is one of the most crucial areas in finance, covering the issue of pricing securities, and company or investment valuation issues along with capital structure formation
Σim = E[min{(Ri − μi), 0} ∗ min{(Rm − μm), 0}]. It can be seen from these equations that there is a difference between the Capital Asset Pricing Model (CAPM) beta and the Estrada’s beta, only when the asset shows upward movement, whereas the market is down
One of the key questions that practitioners have to answer is what model to use in case of company valuations, project valuation or portfolio investment decisions
Summary
Asset pricing is one of the most crucial areas in finance, covering the issue of pricing securities, and company or investment valuation issues along with capital structure formation. With the GDP and productivity growth slowing down in Developed markets (“DMs” from hereafter), EMs are commonly viewed as places for positive future economic prospects This shift in economic performance has drawn attention to pricing of securities in less liquid, less transparent and more shock-prone markets. The main question we are trying to answer in this article is related to the reliability and applicability of the CAPM model to the settings of EMs. As an alternative to traditional CAPM model, this research paper tests the downside risk measures, and the D-CAPM. In contrast to the past research our findings suggest priority of total risk measures over systematic risk measures We attribute this result to the slower than expected integration of Emerging markets into the world markets
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