Three-factor Asset Pricing Model Research Articles

A flexible estimation of sectoral portfolio exposure to climate transition risks in the European stock market

I investigate the exposure of sectoral equity portfolios to climate transition risks by augmenting a three-factor asset pricing model with a green-minus-brown (GMB) factor as a proxy. I estimate the relationship between risk factors and excess returns within an additive mixed model representation, which flexibly captures possible changes in investors’ subjective beliefs as reflected in the determinants of asset pricing. Empirical evidence is provided based on European sectoral portfolios covering the 2016–2021 period. Compared to classic linear models, the results show an improvement in model goodness-of-fit when flexibly estimating the relationship between risk factors and excess returns. I confirm previous studies that exposure to climate transition risks particularly affects high-energy-intensity sectors. I also find heterogeneity in exposure between firms within each sectoral portfolio in terms of the sign and/or magnitude of estimates. Moreover, some firms still have no statistically significant exposure to climate transition risks.

Seasoned equity offerings, return of capital and agency problem: Empirical evidence from Taiwan

Seasoned equity offerings (SEOs) and return of capital (ROC) are activities carried out by listed companies in the capital market. The decision of the company manager to engage in SEOs and ROC is actually in the scope of the agency mechanism. This paper explores the characteristics of SEO and ROC companies and whether SEOs and ROC will affect the company's performance and whether the agency problem will (partially) mediate the impact of SEOs and ROC on company performance. We use the annual data of domestic (Taiwan) listed companies from the Financial Supervisory Commission website and the Taiwan Economic Journal for the 2000–2018 period and adopt the Fama-French three-factor asset pricing model to hierarchical regression analysis to study the mediating role of the agency problem. The empirical results support that SEO companies are mostly in the expansion or growth stage and SEOs reduce company performance, both in the short term and long term. After considering free cash flow, the effect of SEOs on performance declines. The results support that ROC companies are mostly in decline stage and ROC increases long-term company performance. However, free cash flow does not affect the performance of the companies engaging in ROC. This research combines SEO and ROC data, and it is based on the perspective of the agency problem so that we can understand the impact on company performance.

Optimisation of Time-Varying Asset Pricing Models with Penetration of Value at Risk and Expected Shortfall

This study aims to apply value at risk (VaR) and expected shortfall (ES) as time-varying systematic and idiosyncratic risk factors to address the downside risk anomaly of various asset pricing models currently existing in the Pakistan stock exchange. The study analyses the significance of high minus low VaR and ES portfolios as a systematic risk factor in one factor, three-factor, and five-factor asset pricing model. Furthermore, the study introduced the six-factor model, deploying VaR and ES as the idiosyncratic risk factor. The theoretical and empirical alteration of traditional asset pricing models is the study’s contributions. This study reported a strong positive relationship of traditional market beta, value at risk, and expected shortfall. Market beta pertains its superiority in estimating the time-varying stock returns. Furthermore, value at risk and expected shortfall strengthen the effects of traditional beta impact on stock returns, signifying the proposed six-factor asset pricing model. Investment and profitability factors are redundant in conventional asset pricing models.

Network Hypes and Asset Prices of Cryptocurrencies: Empirical Evidence Based on Google-Attention Approach

The rapid development of cryptocurrencies motivates us to examine the factors that drive cryptocurrency prices. Using Google attention innovation ($GAI$) to measure network hype or investor speculation, this paper investigates the effect of network hype in the cryptocurrency market and proposes a three-factor asset pricing model composed of the market, size, and network hype($GAI$) factors. This paper is the first empirical study on asset pricing in cryptocurrency markets and is a unique attempt to value the cryptocurrencies prices using a factor model. The empirical results show: (1) There is a positive and significant effect of network hype in the cryptocurrency market, and network hype plays a significant role in increasing cryptocurrency prices. (2) Average excess returns of cryptocurrencies are negatively correlated with their size and have a significant positive correlation with Google attention innovation. (3) Our three-factor model has strong explanatory power for excess cryptocurrency returns and can explain the momentum, reversal, and liquidity factors in the cryptocurrency market.

Liquidity impact on assets pricing in the context of Fama and French model

The three-factor asset pricing model of Fama and French (1993) was developed as a response to the CAPM limits in explaining the financial asset's return. However, these two models do not take into account that the liquidity factor has consistently proven to have a crucial importance. Therefore, in this research, we study the impact of liquidity on financial assets pricing in presence of Fama and French factors (SMB and HML). We use data of two portfolios of assets listed on the Sao Paulo and Shanghai stock exchanges, over a period of ten years, spreading between January 2003 and December 2012. Our results confirm previous studies in developed markets, and we have shown that liquidity has a significant and negative impact on the expected returns of financial assets listed on emerging markets.

Liquidity impact on assets pricing in the context of Fama and French model

The three-factor asset pricing model of Fama and French (1993) was developed as a response to the CAPM limits in explaining the financial asset's return. However, these two models do not take into account that the liquidity factor has consistently proven to have a crucial importance. Therefore, in this research, we study the impact of liquidity on financial assets pricing in presence of Fama and French factors (SMB and HML). We use data of two portfolios of assets listed on the São Paulo and Shanghai stock exchanges, over a period of ten years, spreading between January 2003 and December 2012. Our results confirm previous studies in developed markets, and we have shown that liquidity has a significant and negative impact on the expected returns of financial assets listed on emerging markets.

Wage Growth and Equity Risk Premia

We develop a simple three-factor consumption-based asset pricing model that includes wage growth as a risk factor, and evaluate whether the model explains six major CAPM anomalies: book-to-market, investment, operating profitability, long-term return reversal, net share issues, and residual variance. Wage growth arises in the pricing kernel by using a non-separable utility over consumption and leisure, and represents the growth in the opportunity cost of enjoying leisure hours. In the model, wage growth earns a negative price of risk, that is, higher wage growth leads to a decline in leisure demand, which increases the marginal utility of consumption for an investor with risk aversion above one. The empirical cross-sectional tests show that the model explains around 50% of the cross-sectional dispersion in average returns of the joint six CAPM anomalies (160 equity portfolios). Further, the proposed model compares favorably with alternative return-based multifactor models widely used in the literature. The risk price estimates for wage growth are significantly negative, while the implied preference parameter (share of leisure) estimates are economically plausible in most cases. Overall, our results suggest that aggregate wage growth can help explaining cross-sectional equity risk premia.

Risk premium contributions of the Fama and French mimicking factors

We take a new look on the Fama and French (1993) three-factor asset pricing model by extracting risk premium contributions for each factor based on solving a system of linear equations. The risk premium contributions become uncorrelated with the underlying factor excess returns and capture the isolated compensation of a given risk factor. We show that the risk premium contributions feature a January-seasonality, which exhibits a negative shift after the year 1993. Furthermore we find that after 1993 the risk premium contributions of the SMB and HML factor are strongly related to sentiment and predictable by dividend yield.

Digesting the Profitability and Investment Premiums: Evidence from the Short Selling Activity

This paper highlights the effects of short selling activity on the profitability and investment premiums. Recently, Fama and French (2015) extend their three-factor asset pricing model by adding profitability and investment factors. Using short interest as a proxy to measure the short selling activity, we find that the stocks without shorting show significant higher profitability premium, while short selling activity has no impact on the investment premium. We also provide evidence that the profitability premium is more likely than the investment premium to be associated with the sentiment-driven mispricing, and short sellers are skilled at eliminating sentiment-driven mispricing. Collectively, our results suggest that the two new Fama-French factors have different underlying attributions. While the profitability premium is more consistent with cash flow-based interpretation, the investment premium is more consistent with risk-based interpretation.

Predicting Fama-French factors based on industry returns in Brazil

There is a vast literature on the predictability of returns based on past information, and many asset pricing models have been tested, such as the Capital Asset Price Model (CAPM) and the three-factor asset pricing model of Fama and French. The purpose of this paper is to answer the question whether Fama-French’s size and value factors (SMB and HML) can be predicted by past returns of 16 portfolios formed by companies from the same industry in Brazil. Our analysis controls for different macroeconomic variables and firm characteristics, such as corporate governance practices, size, dividend yield, book-to-market, among others. The analysis reveals that 14 of 16 industries predict SMB one month ahead. Furthermore, the returns of a few industries predict the volatility of SMB and HML up to three months ahead of time. Considering the explanatory capability of the Fama-French model, the results of this research show that Brazilian industry returns contain valuable information for the SMB and HML factors, demonstrating that investors cannot absorb all the information in a timely manner, resulting in their gradual diffusion throughout the market.

A Modified Fama and French (1993) Three-factor Asset Pricing Model: Evidence from the UK Equity Market

The objective of this study is to examine the modified Fama and French (1993) three-factor asset pricing model, suggested by Cremers et al. (2012), in the UK equity market, over the period from October 1980 to June 2015. The article follows the correct Lewellen et al. (2010) framework for evaluating asset pricing models. In contrast to Michou et al. (2007) and Gregory et al. (2013), the results suggest the use of the modified Fama and French (1993) three-factor asset pricing model in practical applications that require the estimation of expected returns in the UK equity market. The results are robust using the same sample period in Gregory et al. (2013). Overall, the result suggests to follow the correct Lewellen et al. (2010) framework for evaluating asset pricing models in pricing the UK equity market returns.

Three-factor asset pricing model and portfolio holdings of foreign investors: evidence from an emerging market – Borsa Istanbul

This article contributes to the asset pricing literature by offering an alternative missing factor: the excess holdings of foreign investors. To incorporate this factor, we mimic the portfolio of foreign investors in Borsa Istanbul (BIST) with respect to portfolio preferences (foreign ownership) using the Fama and French’s three-factor model. Our findings suggest that market factor, size, and book-to-market (B/M) variables are still statistically significant and Jensen’s alpha is still not significant, and we obtain a statistically significant negative relationship between the excess return of foreign investors’ ownership and the return variation of a given portfolio.

Profitability and Investment Factors for UK Asset Pricing Models

Empirical investigations of the Fama-French three-factor asset pricing model have produced decidedly mixed results, particularly outside of the US market. Two recently proposed alternative multifactor models share a common core of the addition of profitability and investment as factors, but differ in terms of implementation (Fama and French, 2014; Chen, Novy-Marx, and Zhang, 2011). Testing of these models is currently confined to the US market. In this letter we adapt and test these models for the UK and argue that the Fama-French five-factor profitability factor offers the most potential.

Human Capital as an Asset Class Implications from a General Equilibrium Model

This paper derives the value and risk of aggregate human capital in a stochastic equilibrium model with Duffie-Epstein preferences. A three-factor asset-pricing model is derived, where the factors are the market, the capital share, and investment in human capital. When the model is calibrated to match the historical ratio of wages to consumption in the United States, the weight of human capital in aggregate wealth is estimated to be about 93%, well above most previous estimates, and human capital's riskiness is lower than that of the market portfolio.

Consumption growth, preference for smoothing, changes in expectations and risk premium

Abstract This paper derives a relationship between consumption growth, the consumption–wealth ratio and its first-difference, and asset returns. Using quarterly data for sixteen OECD countries, we find that the three-factor asset pricing model explains a large fraction of the variation in real stock returns. The model captures: (i) the concerns of agents with states of the world in which consumption growth is low; (ii) the preference of investors for a smooth consumption path as implied by the intertemporal budget constraint; and (ii) the role played by shifts in expectations about future returns due to positive or negative news about their wealth.

Selected approaches for testing asset pricing models using Polish stock market data

The main objective of this paper was to discuss alternative methods for testing the Fama-French (FF) three-factor asset pricing model. The properties of the selected methods were compared in a simulation study. The main stress was put on the behavior of the selected methods for small samples. The parameters used in the simulation study were obtained based on real data coming from the Polish stock market (Warsaw Stock Exchange). Different sample characteristics such as homoscedasticity, conditional heteroscedasticity and autocorrelation as well as heteroscedasticity of the model were tested.

The four-factor asset pricing model on the Polish stock market

In the three-factor asset pricing model a cross sectional portfolio returns variation is explained by the excess return of the market portfolio (RM), stock capitalisation and a factor associated with the book-to-market (B/M) ratio. This model, however, does not explain the momentum effect. Since this effect is present on many stock markets, the three-factor model is augmented by the momentum factor. This article presents the study of the four-factor asset pricing model on the Warsaw Stock Exchange (WSE) which is one of the largest stock markets in Central and Eastern Europe. The empirical analysis is based on monthly data from the period April 2003–December 2012 which includes different stages of the business cycle. This article shows that momentum is a significant factor on the WSE and the four-factor model describes the returns variation much better than the three-factor model.

Effects of Advertising, Customer Satisfaction, and Research and Development on a Firm's Systematic and Unsystematic Risks

In this study, we examine how advertising, customer satisfaction, and research and development (RD these risks being metrics of interest to both finance executives and senior management. Our studies' findings extend prior studies that primarily considered the effects of marketing initiatives on performance metrics, focusing only on systematic risk. We estimate empirical models by the pooled ordinary least squares and the time-series fixed-effects regression analysis. The results significantly support our hypotheses that higher advertising and higher customer satisfaction lower a firm's total risk, systematic risk and unsystematic risk. R&D is significantly associated with higher levels for a firm's total risk, systematic risk, and unsystematic risk. In addition, these effects are robust to alternative estimates of risks, estimating systematic risk and unsystematic risk using both CAPM and the Fama-French three-factor asset pricing model.

Liquidity and Stock Size Premia in Japanese Regional Financial Markets: An Industry Level Analysis

Equity markets are increasingly being seen as having a important role within the financial architecture focussed towards the financing of Small and Medium Enterprises (SME) firms that dominate regional economies. The high costs involved with lending small amounts to smaller firms in the presence of asymmetric information and the lack of economies to scale substantially reduce the competitiveness of the banking system in issuing cost effective relationship-based finance. Consequently well designed development and alternative investment boards with effective regulation and enforcement of disclosure rules can substantially reduce the high costs normally associated with stock exchange financing options. The Japanese regional exchanges have been able to reap significant economies of scale in achieving horizontal integration of their operations with a common clearing, settlements and payment systems largely through having a shared stable macroeconomic environment. While this enables their ability to compete with the lethargic regional banking sector it also facilitates the study of the informational premiums arising from the asymmetric information of focussing on SME financing. This paper estimates the costs of equity across major industry sectors in the three Japanese regional stock exchanges of Nagoya, Fukuoka and Sapporo as well as the very different internationally-focussed markets of Tokyo and Osaka. The Fama and French (1993) three-factor model Capital Asset Pricing Model is augmented to take account of company size and illiquidity factors that are prominent in regional markets. Results show that premia associated with size are dominant in valuation and cost of equity estimates for the international exchanges of Tokyo and Osaka while liquidity is the dominant factor in the three regional markets. Costs of equity are very low in Tokyo and much higher in Osaka, reflecting the limited role of the equity market in the latter in contrast to its specialization in other financial products. Costs of equity are substantially higher in all three regional exchanges reflecting a high informational or liquidity premium.

MULTIFACTOR ASSET PRICING ANALYSIS OF THE BALTIC STOCK MARKET

This study investigates whether the Fama–French three-factor asset pricing model is applicable for explaining cross-sectional returns of stocks listed in the Baltic stock exchanges. Findings confirm the validity and economic significance of the three-factor model for the Baltic stock market: only investors who chose to invest in value stocks during the reference period achieved positive returns by matching or beating the returns of the stock market index. The monthly returns of 8 Latvian, 13 Estonian and 27 Lithuanian company stocks are analyzed for the time period from June 2002 till February 2010 by the methodology presented in Davis, Fama, and French (2000). Cross-sectional multivariate regression is calculated with stock portfolios representing the book-to-market and capitalization of companies as independent variables along with the stock market index. The study concludes that these three factors in the three-factor model are statistically significant, but, in line with earlier studies, regression intercepts are significantly different from zero and the model is not statistically confirmed.p>