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Article
Publication date: 3 August 2015

Saumya Ranjan Dash and Jitendra Mahakud

This paper aims to investigate whether the use of conditional and unconditional Fama and French (1993) three-factor and Carhart (1997) four-factor asset pricing models

Abstract

Purpose

This paper aims to investigate whether the use of conditional and unconditional Fama and French (1993) three-factor and Carhart (1997) four-factor asset pricing models (APMs) captures the role of asset pricing anomalies in the context of emerging stock market like India.

Design/methodology/approach

The first step time series regression approach has been used to drive the risk-adjusted returns of individual securities. For examining the predictability of firm characteristics or asset pricing anomalies on the risk-adjusted returns of individual securities, the panel data estimation technique has been used.

Findings

Fama and French (1993) three-factor and Carhart (1997) four-factor model in their unconditional specifications capture the impact of book-to-market price and liquidity effects completely. When alternative APMs in their conditional specifications are tested, the importance of medium- and long-term momentum effects has been captured to a greater extent. The size, market leverage and short-term momentum effects still persist even in the case of alternative unconditional and conditional APMs.

Research limitations/implications

The empirical analysis does not extend for different market scenarios like high and low volatile market or good and bad macroeconomic environment. Because of the constraint of data availability, the authors could not include certain important anomalies like net operating assets, change in gross profit margin, external equity and debt financing and idiosyncratic risk.

Practical implications

Although the active investment approach in stock market shares a common ground of semi-strong form of market efficiency hypothesis which also supports the presence of asset pricing anomalies, less empirical evidence has been explored in this regard to support or repute such belief of practitioners. Our empirical findings make an attempt in this regard to suggest certain anomaly-based trading strategy that can be followed for active portfolio management.

Originality/value

From an emerging market perspective, this paper provides out-of-sample empirical evidence toward the use of conditional Fama and French three-factor and Carhart four-factor APMs for the complete explanation of market anomalies. This approach retains its importance with respect to the comprehensiveness of analysis considering alternative APMs for capturing unique effects of market anomalies.

Details

Journal of Asia Business Studies, vol. 9 no. 3
Type: Research Article
ISSN: 1558-7894

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Book part
Publication date: 25 March 2010

Syou-Ching Lai, Hung-Chih Li, James A. Conover and Frederick Wu

We examine explicitly priced financial distress risk in post-1990 equity markets. We add a financial distress risk factor to Fama and French's (1993) three-factor model

Abstract

We examine explicitly priced financial distress risk in post-1990 equity markets. We add a financial distress risk factor to Fama and French's (1993) three-factor model, based on Griffin and Lemmon's (2002) findings that financial distress is not fully captured by the book-to-market factor. We test three-factor and four-factor capital asset pricing models using both annual buy-and-hold analysis and monthly time series analysis across portfolios adjusted for common book-to-market, size, and financial distress factors. We find empirical support for an Ohlson (1980) O-score-based financial distress risk four-factor asset pricing model in the U.S. and Japanese markets.

Details

Research in Finance
Type: Book
ISBN: 978-1-84950-726-4

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Book part
Publication date: 27 November 2017

Hung-Chi Li, Syouching Lai, James A. Conover, Frederick Wu and Bin Li

Lai, Li, Conover, and Wu (2010) propose a four-factor financial distress model to explain stock returns in the U.S. and Japanese markets. We examine this model in the…

Abstract

Lai, Li, Conover, and Wu (2010) propose a four-factor financial distress model to explain stock returns in the U.S. and Japanese markets. We examine this model in the stock markets of Australia, and six Asian markets (Hong Kong, Indonesia, Korea, Malaysia, Singapore, and Thailand). We find broad empirical support for the four-factor financial distress risk asset-pricing model in those markets. The four-factor financial distress asset pricing model improves explanatory power beyond the Fama–French (1993) three-factor asset pricing model in six of the seven Asian-Pacific markets (12 of 14 portfolio groupings), while the Carhart (1997) momentum-based asset pricing model only improves explanatory power beyond the Fama–French model in three of the seven markets (4 of 14 portfolio groupings).

Details

Growing Presence of Real Options in Global Financial Markets
Type: Book
ISBN: 978-1-78714-838-3

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Article
Publication date: 9 November 2015

Nicholas Addai Boamah

The purpose of this study is to explore the applicability of the Fama–French and Carhart models on the South African stock market (SASM). It examines the ability of the…

Abstract

Purpose

The purpose of this study is to explore the applicability of the Fama–French and Carhart models on the South African stock market (SASM). It examines the ability of the models to capture size, book-to-market (BM) and momentum effects on the SASM. The paper, additionally, explores the ability of the Fama–French–Carhart factors to predict the future growth of the South African economy.

Design/methodology/approach

The paper relies on data of 848 firms from January 1996 to April 2012 to examine the size, BM and momentum effects on the SASM. The paper constructs the test assets from a 3 × 3 sort on size and BM and a 3 × 3 sort on size and momentum. The paper estimates momentum as the past six-months’ cumulative return. The momentum portfolios are monthly rebalanced. Additionally, the size and BM portfolios are formed annually at the end of each June.

Findings

Evidence is provided that size, BM and momentum effects exist on the SASM; also, the small- and high-BM firm portfolios, respectively, appear riskier than the big- and low-BM firm portfolios. The paper provides evidence of past winners outperforming past losers aside from the small-firm group. Additionally, the models only partially capture the size and value effects on the SASM. The Carhart model partly captures the momentum effects, but the Fama–French model is unable to describe the returns to the momentum-sorted portfolios. The evidence shows that the models’ factors predict future gross domestic product growth.

Originality/value

The models do not fully describe returns on the SASM; any application of the models on the SASM should be done with caution. The Carhart model better describes returns than the Fama–French model on the SASM. The Fama–French–Carhart factors may relate to the underlying economic risk of the South African economy.

Details

Review of Accounting and Finance, vol. 14 no. 4
Type: Research Article
ISSN: 1475-7702

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Article
Publication date: 8 May 2017

Sanjay Sehgal and Sonal Babbar

The purpose of this paper is to perform a relative assessment of performance benchmarks based on alternative asset pricing models to evaluate performance of mutual funds…

Abstract

Purpose

The purpose of this paper is to perform a relative assessment of performance benchmarks based on alternative asset pricing models to evaluate performance of mutual funds and suggest the best approach in Indian context.

Design/methodology/approach

Sample of 237 open-ended Indian equity (growth) schemes from April 2003 to March 2013 is used. Both unconditional and conditional versions of eight performance models are employed, namely, Jensen (1968) measure, three-moment asset pricing model, four-moment asset pricing model, Fama and French (1993) three-factor model, Carhart (1997) four-factor model, Elton et al. (1999) five-index model, Fama and French (2015) five-factor model and firm quality five-factor model.

Findings

Conditional version of Carhart (1997) model is found to be the most appropriate performance benchmark in the Indian context. Success of conditional models over unconditional models highlights that fund managers dynamically manage their portfolios.

Practical implications

A significant α generated over and above the return estimated using Carhart’s (1997) model reflects true stock-picking skills of fund managers and it is, therefore, worth paying an active management fee. Stock exchanges and credit rating agencies in India should construct indices incorporating size, value and momentum factors to be used for purpose of benchmarking.

Originality/value

The study adds new evidence as to applicability of established asset pricing models as performance benchmarks in emerging market India. It examines role of higher order moments in explaining mutual fund returns which is an under researched area.

Details

Journal of Advances in Management Research, vol. 14 no. 2
Type: Research Article
ISSN: 0972-7981

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Article
Publication date: 8 May 2018

Dmitrij Rubanov and Matthias Nnadi

The purpose of this paper is to examine the effect of international financial reporting standards (IFRS) on the performance of UK investment closed-end trust funds with…

Abstract

Purpose

The purpose of this paper is to examine the effect of international financial reporting standards (IFRS) on the performance of UK investment closed-end trust funds with domestic equity focus using Carhart’s Four-Factor model.

Design/methodology/approach

The paper is based on the Efficient Market Hypothesis, which argues that all available information is already included in the price of assets, and therefore, investors cannot beat the market or generate abnormal returns.

Findings

The results show that on average, UK investment trusts neither do generate abnormal returns, nor is their performance persistent. This paper provides empirical evidence to support the efficient market hypotheses and provides proof that the adoption of IFRS has, on average, a decreasing impact on the excess returns generated by UK investment trusts.

Originality/value

The findings of this paper have business policy implications for investment trust in the UK.

Details

Accounting Research Journal, vol. 31 no. 1
Type: Research Article
ISSN: 1030-9616

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Article
Publication date: 6 February 2017

Jarkko Peltomäki

The purpose of this paper is to present and demonstrate how the use of a multifactor model in the analysis of market timing skill can be misleading because the use of a…

Abstract

Purpose

The purpose of this paper is to present and demonstrate how the use of a multifactor model in the analysis of market timing skill can be misleading because the use of a multifactor model does not suit all investment styles equally well. If the factors of the analysis model do not span the portfolio holdings of a fund with less conventional investment strategy, the use of a multifactor model may even deteriorate the overall inference in measuring the market timing skill of a large sample of funds.

Design/methodology/approach

This study investigates the limitations of multifactor models in the analysis of market timing skill by applying the traditional Treynor-Mazuy and Henriksson-Merton analysis models of market timing skill using a set of “placebo” funds which are “natural” passive market timers.

Findings

The results of the study show that the incorporation of the Carhart four-factor model into the analysis of market timing skill considerably reduces the percentage of significant market timing results. But, as expected, the reduction of bias is not equal for different investment styles, and it works best when the factors of the analysis model are related to the investment style of the placebo portfolio.

Practical implications

This style-related limitation of multifactor models in the analysis of market timing skill may result in detecting funds with less conventional investment strategies as market timers since the factors used in the analysis are not likely to span their investment styles.

Originality/value

This study shows that the use of a multifactor model may lead to inferring passive market timers with less conventional investment styles as market timers. In addition, the findings of the study leave option replication approaches as more preferable bias corrections than multifactor extensions.

Details

International Journal of Managerial Finance, vol. 13 no. 1
Type: Research Article
ISSN: 1743-9132

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Article
Publication date: 21 May 2020

Mashukudu Hartley Molele and Janine Mukuddem-Petersen

The purpose of this paper is to examine the level of foreign exchange exposure of listed nonfinancial firms in South Africa. The study spans the period January 2002 and…

Abstract

Purpose

The purpose of this paper is to examine the level of foreign exchange exposure of listed nonfinancial firms in South Africa. The study spans the period January 2002 and November 2015. Foreign exchange risk exposure is estimated in relation to the exchange rate of the South African Rand relative to the US$, the Euro, the British Pound and the trade-weighted exchange rate index.

Design/methodology/approach

The study is based on the augmented-market model of Jorion (1990). The Jorion (1990) is a capital asset pricing model-inspired framework which models share returns as a function of the return on the market index and changes in the exchange rate factor. The market risk factor is meant to discount the effect of macroeconomic factors on share returns, thus isolating the foreign exchange risk factor. In addition, the study further added the size, value, momentum, investment and profitability risk factors in line with the Fama–French three-factor model, Carhart four-factor model and the Fama–French five-factor model to account for the fact that equity capital markets in countries such as South Africa are known to be partially segmented.

Findings

Foreign exchange risk exposure levels were estimated at more than 40% for all the proxy currencies on the basis of the standard augmented market model. However, after controlling for idiosyncratic factors, through the application of the Fama–French three-factor model, the Carhart four-factor model and the Fama–French five-factor model, exposure levels were found to range between 6.5 and 12%.

Research limitations/implications

These results indicate the importance of controlling for the effects of idiosyncratic facto0rs in the estimation of foreign exchange risk exposure in the context of emerging markets of Sub-Saharan Africa (SSA).

Originality/value

This is the first study to apply the Fama–French three-factor model, Carhart four-factor model and the Fama–French five-factor model in the estimation of foreign exchange exposure of nonfinancial firms in the context of a SSA country. These results indicate the importance of controlling for the effects of idiosyncratic factors in the estimation of foreign exchange risk exposure in the context of emerging markets.

Details

The Journal of Risk Finance, vol. 21 no. 2
Type: Research Article
ISSN: 1526-5943

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Article
Publication date: 21 August 2019

Qiang Bu

The purpose of this paper is to create a quantitative measure that captures the effects of investor sentiment in an objective way.

Abstract

Purpose

The purpose of this paper is to create a quantitative measure that captures the effects of investor sentiment in an objective way.

Design/methodology/approach

The author introduced risk estimation bias (REB) to examine the effects of forecasting error of future market volatility on fund alpha. The author also used GARCH to model the volatility of the REB.

Findings

The author documented a statistically significant relation between REB and realized market volatility. The author also found that the REB plays a significant role in explaining fund alpha.

Originality/value

REB is the first quantitative measure to examine the effects of investor sentiment on risk estimation and fund performance. The GRACH properties of REB provide important information on how investor sentiment fluctuates over time.

Details

Review of Behavioral Finance, vol. 11 no. 4
Type: Research Article
ISSN: 1940-5979

Keywords

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Article
Publication date: 7 August 2017

Karen Paul

This study examines the effect of business cycle, market return and momentum on the financial performance of socially responsible investing (SRI) mutual funds using data…

Abstract

Purpose

This study examines the effect of business cycle, market return and momentum on the financial performance of socially responsible investing (SRI) mutual funds using data from two complete business cycles as defined by the National Bureau of Economic Research (NBER).

Design/methodology/approach

A “fund of funds” approach is used to identify the extent to which SRI financial performance is affected by the macroeconomic climate. The Fama-French Three-Factor model and the Carhart four-factor model are used to bring the results into alignment with commonly used finance methodologies.

Findings

The results indicate that SRI tends to preserve value during economic contraction more than it adds value during economic expansion. Market return is important during both expansion and contraction, while momentum is important only during expansion.

Research limitations/implications

These findings suggest that double screening, for both financial and social performance, enables portfolio managers of SRI funds to have insight into those companies that are particularly vulnerable during times of economic contraction.

Practical implications

These results bring added clarity to the mixed findings found by previous researchers examining the relationship between corporate social performance (CSP) and financial performance.

Social implications

This study reinforces the idea that the financial performance of companies with high ethical standards is comparable to the financial performance of the market as a whole during times of economic expansion and superior to the market as a whole during times of economic contraction.

Originality/value

Business cycle analysis, along with the Fama-French Three-Factor model and the Carhart four-factor model, brings SRI research more into the realm of conventional financial analysis than previous studies.

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