Abstract
In this paper we investigate the explanatory power of the market beta, firm size, and the book-to-market ratio, as well as Value-at-Risk regarding the cross-sectional expected stock returns in a less developed stock market – Taiwan's stock market. The main purpose is to examine whether the Value-at-Risk factor has marginal explanatory power related to the Fama-French three-factor model. The empirical results show that Value-at-Risk can account for the average stock returns at both 1% and 5% significance levels based on cross-sectional regression analysis. Moreover, from the perspective of the time series regression, the Value-at-Risk factor can also demonstrate the variation of the stock market, especially for the larger companies in the Taiwan stock market.
Highlights
The prominent capital asset pricing model (CAPM) of Sharpe (1964), Lintner (1965), and Black (1972) has for decades been the major framework for analyzing the cross sectional variation in expected asset returns, but theory and practice might not always match. Fama and French (1992) draw two different conclusions regarding CAPM – that is, when one allows for variations in the CAPM market β that are unrelated to size, the univariate relationship between β and the average return for 1941–1990 is weak, and β does not suffice to explain this average return
According to Bali and Cakici (2004), this paper examines whether the market factor, firm size, BE/market value of equity (ME), and VaR provide different explanatory powers to the average stock returns under diverse company characteristics in an emerging market – Taiwan
By focusing on downside risk as an alternative measure of risk measured by VaR, this paper investigates whether the new VaR factor plays an important role in explaining Taiwan’s stock returns from January 1996 to December 2009
Summary
The prominent capital asset pricing model (CAPM) of Sharpe (1964), Lintner (1965), and Black (1972) has for decades been the major framework for analyzing the cross sectional variation in expected asset returns, but theory and practice might not always match. Fama and French (1992) draw two different conclusions regarding CAPM – that is, when one allows for variations in the CAPM market β that are unrelated to size, the univariate relationship between β and the average return for 1941–1990 is weak, and β does not suffice to explain this average return. Fama and French (1992) draw two different conclusions regarding CAPM – that is, when one allows for variations in the CAPM market β that are unrelated to size, the univariate relationship between β and the average return for 1941–1990 is weak, and β does not suffice to explain this average return They find no cross-sectional return-beta relationship while controlling for size and the ratio of book-to-market equity (Chan, Chui 1996). Several alternative risk factors have been employed in the literature, for example, the size effect of Banz (1981) and Nunes et al (2012) They finds the market value of equity (ME) and firm size provide an explanation of the cross-section of average returns. Other variables such as the book-to-market equity ratio (BE/ME) (Fama, French 1992, 1993, 1995, and 1996; Rosenberg et al 1985), the price/earnings ratio (Basu 1977), leverage (Bhandari 1988), Value-at-Risk (Bali, Cakici 2004), and profitability and investment patterns (Fama and French 2013) have significant explanatory power for making clear the average expected returns. Hung et al (2004), on the other hand, control for the sign of realized market premia and use higher order asset pricing models to test CAPM
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