Portfolio Excess Returns Research Articles

UJI EMPIRIS MODEL ASSET PRICING LIMA FAKTOR FAMA-FRENCH DI INDONESIA

The main purpose of this study is to evaluate and compare the performances of the Fama-French three- (FF3) and five-factor (FF5) models in the Indonesia stock market. This study also examines whether book-to-market factor (HML) is redundant in explaining the portfolio excess returns in Indonesia. This study employs asset pricing factor of the 2 x 3 sorts and excess returns of 25 Size-B/M, 25 Size-OP, dan 25 Size-Inv portfolios as dependent variables. This study employs Ordinary Least Square (OLS) with monthly time-series data from 2000 to 2015. Based on the average adjusted R2 from the two models, FF5 explains portfolio excess return variations better than FF3, although the profitability and investment factors only display weak effect on the excess returns. If we refer to Merton's (1973) zero-intercept criterion, the both models are not valid in Indonesia, because most intercepts are significant in each set of 25 portfolios. We also find that book-to-market factor is redundant in describing the variation of returns in Indonesia. The test of intercept difference between Indonesia and The US indicates that there are differences of abnormal return and market efficiency in both countries.

Price discovery and asset pricing

This paper tests the hypothesis that price discovery influences asset pricing. Our innovations are twofold. First, we estimate time-varying price discovery for a large number (21) of Islamic stock portfolios. Second, we test using a predictive regression model whether or not price discovery predicts stock excess returns. We find from both in-sample and out-of-sample tests that all 21 portfolio excess returns are predictable. We show that a mean-variance investor by tracking price discovery is able to devise profitable trading strategies.

An analysis of the relation between return and beta for portfolios of Turkish equities

AbstractThe present study investigates the possible existence of a systematic relation between beta and excess-return for portfolios of Turkish equities. In the process, no systematic relation is found between beta and realized portfolio excess-return, in an unconditional sense. However, the study does find a systematic relation between realized portfolio excess-return and beta, conditioned upon the sign of realized market-portfolio excess-return. Moreover, an even stronger systematic relation is found between realized portfolio excess-return and beta, conditioned not only upon the sign, but also the magnitude of realized market-portfolio excess-return, with the estimation of the security market plane (SMP) model. The study has several useful implications for portfolio managers. Firstly, the empirical findings strongly suggest that employment of the SMP model may generate more accurate estimations of expected asset-return, compared with straightforward application of the capital asset pricing model (CAPM)...

The tail risk premia of the carry trades

We study the relationship between the excess returns of portfolios invested in carry trade positions and an innovative global tail risk factor. We find that high interest rate currencies are related to innovations in global currency tail risk. They deliver low returns in times of unexpected high tail risk and high returns in times of unexpected low tail risk suggesting a standard Asset Pricing Theory approach to explain the returns to the carry trade. Our tail risk factor can be understood as the interaction of moment-based factors such as volatility, skewness and kurtosis. Our results tend to indicate that the interaction of moments, i.e. tail risk, rather than the moments alone drives investor behavior. This makes sense since the ultimate risk for carry traders is to reach their funding limits which are set, because of the regulations, on the back of tail risk statistics (Value at Risk) and not simply on the back of the volatility, the skewness or the kurtosis alone. The result holds in other cross-sections of currencies and whether the global tail risk indicators are estimated in the currency, the equity or the bond market.

Skewness and the Relation Between Risk and Return

The relationship between risk and return has been one of the most important and extensively investigated issues in the financial economics literature. The theoretical results predict a positive relation between the two. Nevertheless, the empirical findings so far have been contradictory. Evidence presented in this paper shows that these contradictions are the result of negative skewness in the distribution of portfolio excess return and the fact that the estimation of intertemporal asset pricing models are based on symmetric log-likelihood specifications. Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2015.2201 . This paper was accepted by Jerome Detemple, finance.

A COMPARATIVE STUDY OF CAPM AND SEVEN FACTORS RISK ADJUSTED RETURN MODEL

This study is a comparison and contrast of the predictive powers of two asset pricing models: CAPM and seven factor risk-return adjusted model, to explain the cross section of stock rate of returns in the financial sector listed at Karachi Stock Exchange (KSE). To test the models daily returns from January 2013 to February 2014 have been taken and the excess returns of portfolios are regressed on explanatory variables. The results of the tested models indicate that the models are valid and applicable in the financial market of Pakistan during the period under study, as the intercepts are not significantly different from zero. It is consequently established from the findings that all the explanatory variables explain the stock returns in the financial sector of KSE. In addition, the results of this study show that addition of more explanatory variables to the single factor CAPM results in reasonably high values of R 2 . These results provide substantial support to fund managers,

Global Equity Correlation in Carry and Momentum Trades

We provide a risk-based explanation for the excess returns of two widely-known currency speculation strategies: carry and momentum trades. We construct a global equity correlation factor and show that it explains the variation in average excess returns of both these strategies. The global correlation factor has a robust negative price of beta risk in the FX market. We also present a multi-currency model which illustrates why heterogeneous exposures to our correlation factor explain the excess returns of both portfolios.

Nonparametric testing for anomaly effects in empirical asset pricing models

In this paper, we propose a class of nonparametric tests for anomaly effects in empirical asset pricing models in the framework of nonparametric panel data models with interactive fixed effects. Our approach has two prominent features: one is the adoption of nonparametric functional form to capture the anomaly effects of some asset-specific characteristics and the other is the flexible treatment of both observed/constructed and unobserved common factors. By estimating the unknown factors, betas, and nonparametric function simultaneously, our setup is robust to misspecification of functional form and common factors and avoids the well-known “error-in-variable” problem associated with the commonly used two-pass procedure. We apply our method to a publicly available data set and divide the full sample into three subsamples. Our empirical results show that size and book-to-market ratio affect the excess returns of portfolios significantly for the full sample and two of the three subsamples in all five factor pricing models under investigation. In particular, nonparametric component is significantly different from zero, meaning that the constructed common factors (e.g., small minus big and high minus low) cannot capture all the size and book-to-market ratio effects. We also find strong evidence of nonlinearity of the anomaly effects in the Fama–French 3-factor model and the augmented 4-factor and 5-factor models in the full sample and two of the three subsamples.

Earnings Quality Measures and Excess Returns.

This paper examines how commonly used earnings quality measures fulfill a key objective of financial reporting, i.e., improving decision usefulness for investors. We propose a stock-price-based measure for assessing the quality of earnings quality measures. We predict that firms with higher earnings quality will be less mispriced than other firms. Mispricing is measured by the difference of the mean absolute excess returns of portfolios formed on high and low values of a measure. We examine persistence, predictability, two measures of smoothness, abnormal accruals, accruals quality, earnings response coefficient and value relevance. For a large sample of US non-financial firms over the period 1988–2007, we show that all measures except for smoothness are negatively associated with absolute excess returns, suggesting that smoothness is generally a favorable attribute of earnings. Accruals measures generate the largest spread in absolute excess returns, followed by smoothness and market-based measures. These results lend support to the widespread use of accruals measures as overall measures of earnings quality in the literature.

Effects of Liquidity Management on the Security Market Performance of Companies Listed at the Nairobi Securities’ Exchange

In order to evaluate the effects of liquidity management on the security market performance of companies listed at the Nairobi Securities Exchange, this Census study was carried out on the companies that are listed at the NSE over a 72-month period of January 2008 through December 2013. Using the descriptive research design and the Ordinary Least Squares (OLS) model the study revealed that there is a significant difference between the market performance of liquid companies and that of the illiquid companies, with quick ratio as the measure of liquidity management. Further, the study revealed that liquidity management has an effect on the market return/ performance albeit for the illiquid companies. From the study findings, the liquid portfolio excess return is significantly higher than the illiquid portfolio excess return. This could possibly be because the liquid portfolio companies are very risky while the illiquid portfolio companies are less risky as confirmed by the variations in the coefficient of variation. Because of the failure to influence market performance of liquid companies it was observed that the effect of liquidity management on the market performance of companies listed at the NSE increases with the level of illiquidity. Despite this finding, the study also revealed that all the companies that were studied had a quick ratio of above 1, an indication that they tie a lot of their money in liquid assets. It is recommended that the results of this study should be interpreted diligently because the study focused at a short period of only 72 months and a longer period could yield different results.

The Tail Risk Premia of the Carry Trades

We study the relationship between the excess returns of portfolios invested in carry trade positions and a set of candidate risk factors including an innovative tail risk factor. We find that high interest rate currencies are related to innovations in global currency tail risk. They deliver low returns in time of unexpected high tail risk and high returns in time of unexpected low tail risk suggesting a standard Asset Pricing Theory approach to explaining the returns to the carry trade. Furthermore, our tail risk factor seems to price the returns to the carry trade better than factors such as volatility or skewness tested earlier in the literature. This result is natural because, by its construction, our indicator aggregates in one single variable all the information that these concurrent factors convey. And it makes sense since the ultimate risk for carry traders is to reach their funding limits which are set, because of the regulations, on the back of tail risk statistics (Value at Risk) and not simply on the back of the volatility or the skewness alone. The result holds whether the global tail risk indicators are estimated in the currency, the equity or the bond market.

Corporate Social Responsibility, Stakeholder Risk, and Idiosyncratic Volatility

Idiosyncratic volatility (IV) is regarded as a measure of firm specific information and has been shown to be correlated with ex post lower stock returns. We explore the nexus between IV and corporate social responsibility (CSR) and document that IV is positively correlated with net aggregate CSR and is negatively correlated with a CSR specific risk factor (namely stakeholder risk). Our findings show that: (i) less (more) reliance on market information (firm specific information) implies more difficulty in predictive accuracy; (ii) negative correlation between IV and exposure to the above mentioned CSR risk dimension contributes to explain the puzzle of the negative excess returns of high IV portfolios widely documented in the literature. Our findings are consistent with the hypothesis that CSR reduces flexibility in answering to productive shocks via reduction of stakeholders’ wellbeing, thereby making earnings less predictable in conventional ways, even though they are less exposed to risk of conflicts with stakeholders.

The Economic Value of Predicting Bond Risk Premia: Can Anything Beat the Expectations Hypothesis?

This paper studies whether the evident statistical predictability of bond risk premia translates into economic gains for bond investors. We show that ane term structure models (ATSMs) estimated by jointly tting yields and bond excess returns capture this predictive information otherwise hidden to standard ATSM estimations. The model’s excess return predictions are unbiased, produce regression R 2 s beyond those reported in the literature, exhibit high forecast accuracy, and allow to generate positive bond portfolio excess returns in- and out-of-sample. Nevertheless, these models cannot beat the expectations hypothesis (EH) out-ofsample: the forecasts do not add economic value compared to using the average historical excess return as an EH-consistent estimate of constant risk premia. We show that in general statistical signicance does not necessarily translate into economic signicance because EH deviations mainly matter at short horizons and standard predictability metrics are not compatible with common measures of economic value. Overall, the EH remains the benchmark for investment decisions and should be considered an economic prior in models of bond risk premia.

A note on cointegration methodology in studying stock markets integration

Market integration literature employing cointegration approach often carelessly uses different categories of data, such as price indices, total return indices or indices adjusted with risk-free rate. This article proves using only data adjusted with risk-free rate can be compatible with Capital Asset Pricing Model (CAPM). Based on this finding, links between cointegration system and international CAPM are established. Assuming a group of benchmark markets in a cointegration system is fully integrated with global market, this article applies Gonzalo and Granger (1995) decomposition method to show the single common trend in the system is a proxy for accumulated world portfolio excess return and its loading vector is a vector of estimated betas in CAPM.

An Empirical Test of the Arbitrage Pricing Theory—The Case of Indian Stock Market

With increasing doubt about the validity of the one-factor Capital Asset Pricing Model in pricing financial assets, development of newer models or extensions has become the order of the day. This paper applies one of these developments—the multi-factor Arbitrage Pricing Theory (APT) to explore the relationship between portfolio returns and selected macroeconomic variables. While the chosen model has been extensively tested in developed markets, few such attempts have been made in emerging capital markets. Thus, the purpose of this study is to test the validity of the APT model in India, which has, over the years, gained immense importance in the investors’ minds, the world over. Moreover, the surge in volatility and growth in the Indian capital markets over the past five years makes it an interesting market to study given the rising significance of the risk-return trade-off in such a market. The paper examines ten portfolios, covering 50 stocks, over a five-year period from 1 January 2003 to 1 February 2008 to verify the efficiency and efficacy of the model and finds that APT is a suitable descriptor of asset prices in the Indian context. To overcome the problem of multicollinearity among the macroeconomic explanatory variables, a factor analysis was carried out that resulted in two factors namely the inflation factor and the market index. The excess portfolio returns were regressed on these factors. The regression results display accurate relationships that are significant for each of the 10 portfolios and moderate to high explanatory power. Thus, it concludes that APT is a good fit in India over the chosen sample period.

The Crash Risk Premia of Efficient Carry Trades

Carry trade strategies in which investors sell forward currencies that are at a forward premium and buy forward currencies that are at a forward discount are, on average, profitable. According to the uncovered interest rate parity they should not. A risk premia story might justify the high returns to the carry trades. In this paper we study the relationship between the cross section of excess returns of portfolios invested in carry trade positions and a renewed set of candidate risk factors. Asset pricing theory applies to the currency market: those currencies that have larger loading on risk, especially crash risk, offer a larger mean return in compensation. Especially, we show that crash risk as measured by quantile based statistics such as VaR or CVaR prices better the return to the carry trades than moments based factors such as standard deviation or skewness. This result holds at the portfolio level and at the single currency level. As a result, we show that carry trade strategies that take account of the dispersion of interest rates dominate strategies in which bets are normalized.

Carbon Dioxide Emissions and Asset Pricing

In the modern world, where our lives are heavily dependent on energy consumption, almost all types of consumption involve emissions of carbon dioxide. In this paper, we propose the growth rate of carbon dioxide emissions as a new measure of consumption growth under the standard consumption-based asset pricing (CCAPM) framework. The growth rate of CO2 emissions contributes to the measurement of consumption growth by o ering a more comprehensive coverage of consumption, given its unique advantage of being able to incorporate the transportation and housing component of household consumption. Using the annual growth rate of per capita CO2 emissions as a proxy for the consumption growth under the CCAPM framework, we achieve an estimated relative risk aversion of 5.91, and an implied annual real risk-free rate of 2.18%. In addition, the CO2-based consumption growth captures the consumption risk very well that it explains the cross-sectional variation in excess returns of the US stock portfolios with a small insigni cant pricing error of 0.49 basis point per year.

Misunderstanding Risk and Return?

In a seminal contribution, Campbell (1996) [Campbell, J., 1996, Understanding Risk and Return, Journal of Political Economy 104(2), 298-345] proposed a methodology based on a VAR(1) process to test Merton’s Intertemporal CAPM. Innovations in predictors of portfolio returns are estimated and used as risk factors in an asset pricing model. One key element is the triangularization of the VAR system used to obtain orthogonal innovations. We show that this procedure makes the cross-sectional prices of risk associated with the predictors non identifiable. This is because they depend on the arbitrary ordering of the variables in the VAR. Moreover, since the factors are orthogonal to the market and to one another, the comparison with alternative multi-factor models is problematic. To illustrate, we revisit recent results that allegedly showed that innovations in the predictors drive the two Fama-French factors out in the cross section of portfolio excess returns and concluded that HML and SMB proxy for time-varying investment opportunities. We show that these results are mainly a statistical artifact of the methodology used to obtain orthogonal innovations.

Workforce Diversity and Stock Returns

This paper examines if firms with the most racially diverse employees enjoy superior benefits and performance above the market average. The problem of the study is to analyze risk premiums and risk-adjusted excess returns of a portfolio of firms with most diverse employees in the United States from 2006 to 2011. The results show that the portfolio average risk premiums are positive and greater than the market risk premiums in 2006 and from 2009 to 2011. The portfolio average risk-adjusted excess returns from the single-index model and factor-model are positive, although not statistically significant, for the 5-year holding period intervals.

The Relationship Between Bank Equity Returns And The Brazilian Interest Payments Moratorium

The purpose of this study is to examine the effects of the Brazilian announcement to suspend interest payments on the equity return levels of several large U.S. commercial banks. Using event study methodology, the evidence suggests that the equity prices of the sample banks fully and immediately reflected the relevant information associated with the Brazilian announcement. Additionally, the patterns of portfolio excess returns revealed that the less exposed banks experienced less loss than ether the total bank sample or the more exposed group.