Applying exogenous variables and regime switching to multi-factor models on equity indices

• Authors: Sakowski Paweł , Ślepaczuk Robert , Wywiał Mateusz
• Languages of publication: EN

Abstracts

EN

This article aims to extend the evaluation of classic multi-factor models of Carhart (1997) and to expand analysis performed in Sakowski, Ślepaczuk and Wywiał (2015). We test several modifications of these models to take into account different dynamics of equity excess returns between emerging and developed equity indices. Proposed extensions include volatility regime switching mechanism and three new risk factors. Additionally, we introduce common- and country-specific variables in order to control for global risk. Instead of individual stocks, we use weekly data of 81 world investable equity indices in the period of 2000−2015. We find substantial differences between results for classical models on single stocks and models evaluated for equity indices. Moreover, we observe solid discrepancies between results for developed and emerging markets. Introducing new risk factors and additional variables increase explanatory power of models.

Keywords

EN

asset pricing models; equity risk premia; market price of risk; emerging and developed equity indices

• Publisher: Wydział Nauk Ekonomicznych Uniwersytetu Warszawskiego
• Journal: Ekonomia. Rynek, Gospodarka, Społeczeństwo
• Year: 2016
• Issue: 47
• Pages: 79-121

Contributors

author

Sakowski Paweł

• Faculty of Economic Sciences, University of Warsaw

author

Ślepaczuk Robert

• Faculty of Economic Sciences, University of Warsaw

author

Wywiał Mateusz

• Faculty of Economic Sciences, University of Warsaw

References

• Ammann, Manuel, and Michael Verhofen. 2006. “The Effect of Market Regimes on Style Allocation.” Financial Markets and Portfolio Management 20 (3): 309−337.
• Angelidis, Timotheos, and Nikolaos Tessaromatis. 2014. Global Portfolio Management Under State Dependent Multiple Risk Premia.” In: Proceedings of 2nd Economics and Finance Conference, Vienna eds. Klara Čermáková and Jiri Rotschedl, 49−82. Prague:International Institute of Social and Economic Sciences and University of Economics, Faculty of Economics, Prague.
• Arshanapalli, Bala G., Daniel T. Coggin, and John Doukas. 1998. “Multifactor Asset Pricing Analysis of International Value Investment Strategies.” Journal of Portfolio Management 24 (757): 10−23
• Asness, Clifford S. 1995. The Power of Past Stock Returns to Explain Future Stock Returns. Unpublished working paper Applied Quantitative Research.
• Asness, Cliff, Andrea Frazzini, Aand Lasse H. Pedersen. 2013. Quality minus junk. http://www.econ.yale.edu/~shiller/behfin/2013_04‒10/asness-frazzini-pedersen.pdf (accessed: 18.09.2016).
• Black, Fischer, Michael C. Jensen, and Myron Scholes. 1972. “The Capital Asset Pricing Model: Some Empirical Tests.” In: Studies in the Theory of Capital Markets, ed. Michael C. Jensen. New York: Praeger.
• Cakici, Nusret, Frank J. Fabozzi, and Sinan Tan. 2013. “Size, Value, and Momentum in Emerging Market Stock Returns.” Emerging Markets Review 16: 46−65.
• Carhart, Mark M. 1997. “On Persistence in Mutual Fund Performance.” Journal of Finance 52 (1): 57−82.
• Chen, Long, Robert Novy-Marx, and Lu Zhang. 2011. “An Alternative Three-Factor Model.” https://papers.ssrn.com/sol3/papers.cfm? abstract_id=1418117&rec=1&srcabs=1567616&alg=1&pos=8 (accessed: 18.09.2016).
• Connor, Gregory, and Sanjay Sehgal. 2001. “Tests of the Fama and French Model in India.” London School of Economics and Political Science Discussion Paper 379: 1−23.
• Davis, James L., Eugene F. Fama, and Kenneth R. French. 2000. “Characteristics, Covariances, and Average Returns: 1929 to 1997.” Journal of Finance 55 (1): 389−406.
• Donadelli, Michael, and Lorenzo Prosperi. 2011. The Equity Risk Premium: Empirical Evidence From Emerging Markets. https://papers.ssrn.com/sol3/papers.cfm? abstract_id=1893378 (accessed: 18.09.2016).
• Duarte, Fernando, and Carlo Rosa. 2015. The Equity Risk Premium: A Review of Models. https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr714.pdf (accessed: 18.09.2016).
• Fama, Eugene F., and Kenneth R. French. 1992. “The Cross-Section of Expected Stock Returns.” Journal of Finance 47 (2): 427−465.
• Fama, Eugene F., and Kenneth R. French. 2012. “Size, Value, and Momentum in International Stock Returns.” Journal of Financial Economics 105 (3): 457−472.
• Fama, Eugene F., and Kenneth R. French. 2015. “A Five-Factor Asset Pricing Model.” Journal of Financial Economics 116 (1): 1−22.
• oye, James, Dušan Mramor, and Marko Pahor. 2013. “A Respecified Fama French Three-Factor Model for the New European Union Member States.” Journal of International Financial Management & Accounting 24 (1): 3−25.
• oye, James, Dušan Mramor, and Marko Pahor. 2013. “A Respecified Fama French Three-Factor Model for the New European Union Member States.” Journal of International Financial Management & Accounting 24 (1): 3−25.
• Griffin, John M. 2002. “Are the Fama and French Factors Global or Country Specific? ” Review of Financial Studies 15: 783−803.
• Hammerschmid, Regina, and Harald Lohre. 2014. Regime Shifts and Stock Return Predictability. https://papers.ssrn.com/sol3/papers.cfm? abstract_id=2445086&rec=1&srcabs=2505732&alg=1&pos=10 (accessed: 18.09.2016).
• Hou, Kewei, Andrew G. Karolyi, Bong Chan Kho. 2011. “What Factors DriveGlobal Stock Returns? ” Review of Financial Studies 24: 2527−2574.
• Jegadeesh, Narasimhan, and Sheridan Titman. 1993. “Returns to Buying Winners And Selling Losers: Implications for Stock Market Efficiency.” Journal of Finance 48 (1): 65−91.
• Lakonishok, Josef, Andrei Shleifer, and Robert W. Vishny. 1994. “Contrarian Investment, Extrapolation, and Risk.” Journal of Finance 49 (5): 1541−1578.
• Lieksnis, Raimonds. 2010. “Multifactor Asset Pricing Analysis of the Baltic Stock Market.” Ekonomika 89 (4): 85−95.
• Lintner, John. 1965. “The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets.” Review of Economics and Statistics 47 (1): 13−37.
• Liu, Weimin. 2004. Liquidity Premium and a Two-Factor Model. EFA 2004 Maastricht Meetings Paper 44, September 2003, 0−52.
• Rahim, Ruzita Abdul, and Abu Hassan Shaari Mohd Noor. 2006. “Comparison between Fama and French Model and Liquidity-Based Three-Factor Models in Predicting the Portfolio Returns.” Asian Academy of Management Journal and Finance 2 (2): 43−60.
• Sakowski, Paweł, Robert Ślepaczuk, and Mateusz Wywiał. 2015. “Cross-sectional Returns from Diverse Portfolio of Equity Indices with Risk Premia Embedded.” Quantitative Methods in Economics 16 (2): 89−101.
• Sakowski, Paweł, Robert Ślepaczuk, and Mateusz Wywiał. 2016a. “Cross-sectional Returns with Volatility Regimes from Diverse Portfolio of Emerging and Developed Equity Indices.” eFinanse 12 (2): 23−35.
• Sakowski, Paweł, Robert Ślepaczuk, and Mateusz Wywiał. 2016b. “Do Multifactor Models Produce Robust Results? Econometric and Diagnostic Issues in Equity Risk Premia Study.” Studia Ekonomiczne. Zeszyty Naukowe Uniwersytetu Ekonomicznego w Katowicach (forthcoming).
• Sharpe, William F. 1964. “Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions of Risk.” Journal of Finance 19 (3): 425−442.
• Tan, Min. 2013. Regime Switching Behaviour of the UK Equity Risk Premium. Ph.D. thesis, University of Birmingham.
• Wu, Xueping. 2002. “A Conditional Multifactor Analysis of Return Momentum.” Journal of Banking and Finance 26: 1675−1696.

Identifiers

DOI

10.17451/eko/47/2016/210