Systematic and multifactor risk models revisited

Systematic and multifactor risk models are revisited via methods which were already successfully developed in signal processing and in automatic control. The results, which bypass the usual criticisms on those risk modeling, are illustrated by several successful computer experiments.Comment: First Paris Financial Management Conference, Paris : France (2013

Is Idiosyncratic Volatility Priced? Evidence from the Shanghai Stock Exchange

This paper employs the mimicking portfolio approach of Fama and French (1996) and asks whether idiosyncratic volatility is priced. This paper also provides evidence on whether returns on small stocks are higher in January than in remaining months. Our findings reveal that (a) idiosyncratic volatility is priced; and, (b) the multifactor model provides a better description of average returns than the traditional CAPM. We also find that the absolute pricing errors of the CAPM are large when compared with the multifactor model. We argue that firm size and idiosyncratic volatility may serve as proxies for systematic risk. We also dismiss the claim that returns on small stocks are on average higher in January than in remaining months. In summary, investors interested in taking additional risks should invest in small and low idiosyncratic volatility firms in addition to the market portfolio. This is because our findings indicate that investors can generate substantial returns by investing in strategies unrelated to market movements.Idiosyncratic Volatility, Firm Size, Asset Pricing, China.

Pricing of Equities in China: Evidence from the Shanghai Stock Exchange

In this paper we compare the performance of the traditional CAPM with the multifactor model of Fama and French (1996) for equities listed in the Shanghai Stock Exchange. We also investigate the explanatory power of idiosyncratic volatility and respond to the claim that multifactor model findings can be explained by the turn of the year effect. Our results show that firm size, book to market equity and idiosyncratic volatility are priced risk factors in addition to the theoretically well specified market factor. As far as the turn of the year effect is concerned we reject the claim that the findings are driven by seasonal factors. Our findings have implications for both academic researchers and practitioners. This is because we demonstrate that by following the investment strategies investigated in this paper superior returns could be generated – returns in addition to those offered by the market. Of course this is only applicable to those investors who are willing to take additional risks in order to generate additional returns. In summary, our results show that a broader asset pricing model such as the one investigated in this paper does a much better job than the single index CAPM.Asset Pricing, CAPM, China, Small Firm Effect, Turn of the Year Effect.

Equity Premium: - Does it exist? Evidence from Germany and United Kingdom

Malkiel and Xu (1997) state that idiosyncratic volatility is highly correlated with size and that it plays a powerful role in explaining expected returns. In this paper we ask (a) whether idiosyncratic volatility is useful in explaining the variation in expected returns; and, (b) whether our findings can be explained by the turn of the year effect. We find that (a) our three-factor model provides a better description of expected returns than the CAPM. That is, we find that firm size and idiosyncratic volatility are related to security returns. In addition, we also find that our findings are robust throughout the sample period. We show that the CAPM beta alone is not sufficient to explain the variation in stock returns.Idiosyncratic Volatility, Size Effect, CAPM, Risk Premia

Idiosyncratic Volatility Matter? New Zealand Evidence

Standard asset pricing models ignore idiosyncratic risk. In this study we examine if stock idiosyncratic or unique risk affects returns for New Zealand stocks using the factor portfolio mimicking approach of Fama and French (1993, 1996). We find evidence of a negative relationship between firm size and a stock’s idiosyncratic volatility. Small firms and firms with high idiosyncratic risk also generate positive risk premia after controlling for market returns. We find no evidence of seasonal effects that can explain our findings. Our study provides support for an asset-pricing model with multiple risk factors.Idiosyncratic volatility, Asset Pricing, Unique risk

Idiosyncratic Volatility: Evidence from Asia

The traditional Capital Asset Pricing Model states that assets can earn only higher returns if they have a high beta. However, evidence shows that the single risk factor is not quite adequate for describing the cross-section of stock returns. The current consensus is that firm size and book-to-market equity factors are pervasive risk factors besides the overall market factor. Malkiel and Xu (1997 and 2000) further the debate in empirical asset pricing by stating that idiosyncratic volatility is useful in explaining the cross-sectional expected returns. In this paper we provide international evidence on the relationship between expected stock returns, overall market factor, firm size and idiosyncratic volatility. Our findings suggest that size and idiosyncratic volatility premium are real and pervasive. We find that small and high idiosyncratic volatility stocks generate superior returns and hence suggest that such firms carry risk premia. Our findings also suggest that idiosyncratic volatility is more powerful than the CAPM beta and the firm size effect. Our findings challenge the portfolio theory of Markowitz (1952) and the CAPM of Sharpe (1964), which advances the notion that it is rational for a utility maximizing investor to hold a well-diversified portfolio of investments to eliminate idiosyncratic risks.Idiosyncratic risk, Portfolio Theory, Capital Asset Pricing Model, Size effect and Beta.

Small Firm Effect, Liquidity and Security Returns: Australian Evidence

Standard asset pricing models ignore the costs of liquidity. In this study we advance the ongoing debate on empirical asset pricing and test if liquidity costs (as proxied by turnover rate, turnover ratio and bid-ask spread) affect stock returns for Australian stocks. Our tests use the factor portfolio mimicking approach of Fama and French (1993, 1996). We find small and less liquid firms generate positive risk premia after controlling for market returns and firm size. We find no evidence of any seasonal effects that can explain our multifactor asset pricing model findings. In summary, our study provides support for a broader asset-pricing model with multiple risk factors.Liquidity, Turnover, Asset Pricing, and Closing Bid-Ask Spread

Multifactor consumption based asset pricing models using the US stock market as a reference: Evidence from a panel of developed economies

In this paper we extend the time series analysis to the panel framework to test the C-CAPM driven by wealth references for developed countries. Specifically, we focus on a linearised form of the Consumption-based CAPM in a pooled cross section panel model with two-way error components. The empirical ndings of this two-factor model with various specifications all indicate that there is significant unobserved heterogeneity captured by cross-country fixed e¤ects when consumption growth is treated as a common factor, of which the average risk aversion coefficient is 4.285. However, the cross-sectional impact of home consumption growth varies dramatically over the countries, where unobserved heterogeneity of risk aversion can also be addressed by random effects

Heterogeneity in the Effect of Common Shocks on Healthcare Expenditure Growth

Health care expenditure growth is affected by important unobserved common shocks such as technological innovation, changes in sociological factors, shifts in preferences and the epidemiology of diseases. While common factors impact in principle all countries, their effect is likely to differ across countries. To allow for unobserved heterogeneity in the effects of common shocks, we estimate a panel data model of health care expenditure growth in 34 OECD countries over the years 1980 to 2012 where the usual fixed or random effects are replaced by a multifactor error structure. We address model uncertainty with Bayesian Model Averaging, to identify a small set of important expenditure drivers from 43 potential candidates. We establish 16 significant drivers of healthcare expenditure growth, including growth in GDP per capita and in insurance premiums, changes in financing arrangements and some institutional characteristics, expenditures on pharmaceuticals, population aging, costs of health administration, and inpatient care. Our approach allows us to derive estimates that are less subject to bias than in previous analyses, and provide robust evidence to policy makers on the drivers that were most strongly associated with the growth in health care expenditures over the past 32 years

Risk and return nexus in Malaysian stock market: Empirical evidence from CAPM

This paper examines the applicability of CAPM in explaining the risk-return relation in the Malaysian stock market for the period of January 1995 to December 2006. The test, using linear regression method, was carried out on four models: the standard CAPM model with constant beta (Model I), the standard CAPM model with time-varying beta (Model II), the CAPM model conditional on segregating positive and negative market risk premiums with constant beta (Model III), as well as the CAPM model conditional on segregating positive and negative market risk premiums with time varying beta (Model IV). Empirical results indicate that both the standard CAPM models (Model I and Model II) are statistically insignificant. However, the CAPM models conditional on segregating positive and negative market risk premiums (Model III and Model IV) are statistically significant. In addition, this study also discovers that time varying beta provides better explanatory power.Stock market; CAPM; time-varying beta