Priced Risk Factor Research Articles

Strong vs. stable: the impact of ESG ratings momentum and their volatility on the cost of equity capital

AbstractWe test whether in the cross-section of European stocks, the cost of equity capital is more strongly affected by the (upward) “slope” (identified as momentum over a period of time) of their ESG scores or by their “stability” (identified as the volatility of the scores over a period of time), measured around a given slope. We find that short-term ESG momentum is priced in the cross-section of stock returns but that it may increase or decrease the ex-ante cost of capital depending on the specific sample investigated. While short-term ESG momentum may represent a novel, priced systematic risk factor, there is also strong evidence that a ESG spread strategy that buys (sells) low (high) ESG score volatility stocks leads to a significant alpha and lower the ex-ante cost of capital. This suggests that ESG rating stability may carry a more reliable reward than improvements do, in terms of ex-ante equity cost of capital. These results are robust to the use of different sub-samples (over firms and sub-periods) and to forming the two quantitative ESG signals on the basis of alternative rating data.

Pricing Intellectual Capital in Asset Pricing Models: A study on Shanghai Stock Exchange

This study aims to examine the validity of intellectual capital as a priced risk factor in the asset pricing model. We have used the data of companies listed on the Shanghai Stock Exchange from 2000 to 2021. To test the models, time series as well as cross sectional analysis have been done using the Fama-MacBeth method. The results show that intellectual capital is a significant risk factor and after augmenting IC into asset pricing models improves the explanatory power to explain the variation in the stock returns. It further suggests that IC can be priced in the Chinese market, over and above what can be explained by covariance risk, size, value, investment and profitability factors.

Gold, platinum, and mutual fund flows

Huang and Kilic (2019) demonstrate that gold to platinum price ratio (GP), which proxies for tail risk in the economy, is a priced risk factor in the cross-section of stock returns. We document that GP negatively affects the mutual fund flows of the active equity funds. In cross-sectional regressions, we find that funds with high betas with respect to the change in GP (βΔGP) have larger future fund flows, as such funds provide a hedge against economic distress. Further, βΔGP helps predict the future performance of the fund in the next few quarters. βΔGP also relates negatively to the downside risk of the fund, implying that funds could potentially reduce their left-tail risk by tilting towards securities with above average βΔGP. We also examine the flows to active corporate bond funds and passive funds. While these effects of GP are largely observable for passive funds, they are not as strongly observable for corporate bond funds.

Robo advisors and access to wealth management

We investigate how access to robo-advisors impacts the financial investment and welfare of less-wealthy investors. We leverage a quasi-experiment where a major U.S. robo-advisor significantly expands access by reducing its account minimum, increasing participation by middle-class investors but not the poor. A benchmark model calibrated to portfolio-level data rationalizes this increase: middle-class investors want sophisticated investing but cannot achieve it themselves. Their welfare rises moderately, driven by advanced features like multi-dimensional glide-paths and additional priced risk factors. Middle-age investors gain three times more than millennials. Our results reveal novel margins of demand for robo-advisors, helping explain their sustained growth.

AirFactors – Examining Priced Risk Factors in Short Term Rental Investments

AirFactors – Examining Priced Risk Factors in Short Term Rental Investments

Carbon dioxide and asset pricing: Evidence from international stock markets

We use carbon dioxide (CO2) emissions growth to measure consumption risk within a consumption-based capital asset pricing model framework. Given the comprehensive worldwide coverage of CO2 emissions, this measure allows us to use the full history of stock market data in the US, Europe, the world, and fifteen international markets. For the US (Europe/the world), we are able to explain the observed equity market premium with a relative risk aversion of 6 (10/12), which is less than half the size of that estimated using the canonical expenditures-based consumption growth measure. The average estimated relative risk aversion across fifteen other international markets is 5. We also find evidence that the growth of CO2 emissions is a priced risk factor that captures the cross section of stock portfolio returns.

New ESG rating drivers in the cross‐section of European stock returns

AbstractWe assess the performance of two quantitative signals based on ESG scores across a large, multi‐national cross‐section of European stock returns. We test whether the cost of equity capital is more influenced by the upward momentum (measured over time) of the ESG scores of the firms issuing stocks or by their stability (identified as the volatility of the scores over time), measured around a changing mean level. We find that short‐term ESG momentum over 1 month has a significant impact on the cross‐section of stock returns, lowering the anticipated cost of capital and leading to positive average abnormal returns. This suggests that short‐term ESG momentum may represent a novel, priced systematic risk factor. Furthermore, we find strong evidence that an ESG volatility spread strategy which buys low ESG score volatility stocks and sells high volatility ones, generates a substantial alpha and affects the ex‐ante cost of capital. Both quantitative ESG signals result in portfolio sorting and long‐short strategies that enhance the overall sustainability profile of the issuing firms without compromising the raw average of their ESG scores.

Freight insurance pricing strategy based on an online freight platform

PurposeThe development of digital technology has provided technical support to various industries. Specifically, Internet-based freight platforms can ensure the high-quality development of the logistics industry. Online freight platforms can use cargo transportation insurance to improve their service capabilities, promote their differentiated development, create products with platform characteristics and increase their core competitiveness.Design/methodology/approachThis study uses a generalised linear model to fit the claim probability and claim intensity data and analyses freight insurance pricing based on the freight insurance claim data of a freight platform in China.FindingsConsidering traditional pricing risk factors, this study adds two risk factors to fit the claim probability data, that is, the purchase behaviour of freight insurance customers and road density. The two variables can significantly influence the claim probability, and the model fitting outcomes obtained with the logit connection function are excellent. In addition, this study examines the model results under various distribution types for the fitting of the claim intensity data. The fitting outcomes under a gamma distribution are superior to those under the other distribution types, as measured by the Akaike information criterion.Originality/valueWith actual data from an online freight platform in China, this study empirically proves that a generalised linear model is superior to traditional pricing methods for freight insurance. This study constructs a generalised linear pricing model considering the unique features of the freight industry and determines that the transportation distance, cargo weight and road density have a significant influence on the claim probability and claim intensity.

Asset pricing tests for pandemic risk

This study examines the relationship between the COVID-19 pandemic and stock returns. We find that pandemic risk is a significant determinant of cross-sectional stock returns. The time-varying effective reproduction number from the susceptible-infectious-recovered epidemic model is introduced as a proxy measure for COVID-19 risk. The two-step generalized method of moments estimation results indicate that the COVID-19 factor commands a significant positive risk premium. The results are robust to different test assets, serial interval parameters, portfolio construction methods and alternative proxy measures, providing strong empirical evidence that the COVID-19 factor is a priced risk factor during the COVID-19 pandemic.

Asymmetric and Lag Effects of Industry Risk Factors on the Malaysian Oil and Gas Stocks

This study examines asymmetric and the lag effects of oil price, gas price, and exchange rate on stock performance of the Malaysian oil and gas sub-industries. Using company-level data and multi factor asset pricing models, this study found that oil price, gas price, exchange rate, and common systematic risk factors such as market, size, and book-to-market have significant effects on the stock performance of Malaysian oil and gas sub-industries, but these exposures remain heterogeneous. Oil price and exchange rate show strong asymmetrical impacts on stock performance when decomposed into oil price increases (decreases) and exchange rate depreciation (appreciation). Increases in oil price and exchange rate depreciation have a greater impact on stock performance of oil and gas industry than decreases in oil price and exchange rate appreciation. Oil price, gas price, and exchange rate exhibit lag effects on the performance of oil and gas stocks. The findings have important asset pricing implications for profitable investment and portfolio strategies based on oil and gas risk factors for oil-exporting country.JEL Classifications: C13; C58; G10; G12; G14; Q4

Microblogging Perceptive and Pricing Liquidity: Exploring Asymmetric Information as a Risk Determinant of Liquidity in the Pandemic Environments

<p><big>Liquidity can be a real phenomenon for execution of the financial holding. Its risk falls in debate to impose a conditional cost on the counterparty. The time-varying liquidity is often linked to the expected fundamental value of an investment. In this work, the microblogging-based informed transaction is examined as a determinant of the liquidity-facilitating cost. Most importantly, this study investigates the economic blockade era and post-pandemic uncertainty. The sentiment indicators were found to be determinants of liquidity. These findings were consistent in the post-pandemic period. However, the investor pessimistic sentiment was a priced risk factor in liquidity during the economic blockade period. Based on the Bayesian theorem, a relativeness was reported between sentiment indicators and the liquidity-facilitating cost. The same findings were depicted in environments of the pandemic era. Nevertheless, the posterior probability indicated an occurrence of the liquidity-associated cost in response to the pessimistic sentiments during the economic blockade period. This quantification may have potential implications in terms of exploring liquidity from the microblogging perceptive.</big></p>

Better Not Forget: On the Memory of S&P 500 Survivor Stock Companies

This study explores the dependency structure of S&P 500 survivor stocks. Using a hand-collected sample of stocks that survived in the S&P 500 since March 1957, we employ rescaled/range analysis to investigate survivors. First, we find nonlinearities in the return processes of survivor stocks due to Paretian tails. Second, the return processes of very long-lived outliers exhibit long-term memories with Hurst exponents that significantly exceed one half on average. Third, sample-split tests reveal that the memory on average has virtually not changed over time—that is, survivor stocks do not forget. Fourth, and last, the long-term memory of survivor stocks appears to be unrelated to their exposures to traditional asset pricing risk factors.

Volatility and correlation of Islamic and conventional indices during crises

We examine the correlation and volatility of Islamic indices and their conventional counterparts during the 2008–2009 Global Financial Crisis as well as the Covid-19 pandemic. We provide evidence that the volatility of Islamic indices is relatively lower than that of conventional peers during turmoil periods. Consistent with the decoupling hypothesis, our results indicate that the volatility of Islamic and the volatility of conventional indices tend to move in tandem in tranquil times but diverge in times of crises. Our results also indicate that the correlation between Islamic and conventional indices is a priced risk factor for Islamic index returns.

Liquidity Pricing Risk and Crude Oil Market: Analyzing the Liquidity as a Priced Factor in Yields during the Pandemic Uncertainty

The liquidity risk can impact the transaction execution with the significant losses. In the crude oil market, this work examines the market liquidity as a priced risk factor in yields. This area may considerably matter to be investigated, while an unprecedented slump is observed in the crude oil price during the pandemic period. The analysis is derived through the time series and multivariate algorithm methods. Pre-pandemic uncertainty and in the era of easing coronavirus-related restrictions, the liquidity was not priced in returns of the same trading session. In the period of economic restrictions, the crude oil trading was exposed to the liquidity risk for the same trading session. This risk was compensated by a premium return in environments of price uncertainty. In this debate, the liquidity risk was a priced risk factor in yields. Evidence from the VAR findings reports, that the past time series of the liquidity was priced in returns before the pandemic crisis takes place. Post-easing economic restrictions and in the era of pandemic-related restrictions, the past times series of the liquidity was not priced in returns. This quantification of the market liquidity may be more applicable for the liquidity risk management in the crude oil market.

Does electronic economics matter to financial technology firms?

This paper addresses the notion of electronic economics by examining financial technology (fintech) firms' performance and corporate governance quality, using data from the United States. The findings support our maintained assumption that due to the economics of electronic platforms perused by financial technology firms, these firms outperform firms from other industries (non-Fintech). The final sample comprises 1,712 company-year observations between 2010 and 2019 (pre-COVID-19). The evidence suggests that our corporate governance quality index, developed from Organisation of Economic Cooperation and Development (www.oecd.org/corporate/corporate-governance-factbook.htm, 2019) guidelines, accurately captures corporate governance quality in the United States, principally due to the inclusion of an anti-bribery policy indicator, in the index. The results suggest that this evidence is not merely an artefact due to the corporate governance quality index potentially capturing priced risk factors. Our findings reveal that fintech firms have superior corporate governance quality than non-fintech and that fintech firms place more reliance on internal versus external corporate governance mechanisms, vis-a-vis companies in other industries.

Investor Sentiment and Market-Wide Liquidity Pricing

The recent asset pricing evidence on the return-liquidity risk relationship is mixed and somewhat ambiguous. We reevaluate the importance of market-wide liquidity and liquidity risk for equity pricing by taking the role of investor sentiment into account. Regarding the market-wide liquidity level as a systematic factor, we find that high market sentiment tends to weaken the effect of market-wide illiquidity - both expected and unexpected - on stocks returns. With respect to systematic liquidity exposure as a priced risk factor, the results show that the effect of exposure to shocks in aggregate liquidity on expected returns is significantly positive when sentiment is low, while it is significantly negative when sentiment is high suggesting that “rational” asset pricing is only valid in the low sentiment regime without too much turbulence caused by sentiment traders.

Is Information Quality a Priced Risk Factor?: Evidence From the Relation Between Accounting Information Quality and Stock Comovement

Is Information Quality a Priced Risk Factor?: Evidence From the Relation Between Accounting Information Quality and Stock Comovement

New insights on the asset growth anomaly: evidence from Europe*

This study provides insights into the well-documented asset growth anomaly using an integrated European stock market sample derived from 21 countries. We assess whether the anomaly in Europe is attributable to risk or mispricing. In doing so, we examine whether the asset growth effect on stock returns is dependent on the valuation signals contained in equity financing activities. Moreover, we determine whether it is derived from firms with existing market expectation errors. Finally, we explicitly test whether asset growth is a priced risk factor using the common two-stage cross-sectional regression (2SCSR) methodology. Overall, our evidence suggests that the underlying origins of the asset growth anomaly in Europe at the aggregate level are relatively consistent with a risk-based explanation.

Fat tails, serial dependence, and implied volatility index connections

This paper accounts for fat tails and serial dependence for implied volatility index network connections among equity and commodity markets using Bayesian vector heterogeneous autoregressions. I analyse the information content of such connections over short-, medium- and long-horizons for predicting underlying asset returns and whether conventional asset pricing risk factors explain the variation of portfolios that sort on directional connections. Including network connections within the information set yields significant gains when forecasting underlying asset returns. Sorting underlying assets on directional connections shows that investors can hedge against temporary changes to investment opportunities at horizons of less than one month.

Accruals mispricing versus risk: Analyzing the influence of external monitoring in Brazil

AbstractIn this paper, we examine the role of external monitoring as an alternative mechanism of corporate governance pertaining to the risk and mispricing of accruals in the Brazilian market. The results provide evidence of the accruals anomaly for companies with low external monitoring and evidence that is stronger when evaluating the discretionary component of accruals. Our analysis does not support the conclusion that total and discretionary accruals represent price risk factors, which suggests that the evidence of anomaly results from mispricing. Our evidence contributes to the growing literature on accruals pricing in emerging markets, by adding elements such as the influence of external monitoring and the level of investor sophistication, hereby represented by market analysts and institutional investors. Our study provides additional evidence that the presence of these intermediary agents creates an external layer of control capable of contributing positively to the process of disclosure and pricing of financial information. Thus, the role of such intermediaries as external monitors in emerging markets can be potentially significant for correctly pricing accruals. While Brazil has its own unique institutional characteristics, our findings confirm the evidence obtained for other countries.