Value versus Growth: The International Evidence

Value stocks have higher returns than growth stocks in markets around the world. For the period 1975 through 1995, the difference between the average returns on global portfolios of high and low book-to-market stocks is 7.68 percent per year, and value stocks outperform growth stocks in twelve of thirteen major markets. An international capital asset pricing model cannot explain the value premium, but a two-factor model that includes a risk factor for relative distress captures the value premium in international returns.     

Local risk factors in emerging markets: Are they separately priced?

We provide new evidence on the pricing of local risk factors in emerging stock markets. We investigate whether there is a significant local currency premium together with a domestic market risk premium in equity returns within a partial integration asset pricing model. Given previous evidence on currency risk, we conduct empirical tests in a conditional setting with time-varying prices of risk. Our main results support the hypothesis of a significant exchange risk premium related to the local currency risk. Exchange rate and domestic market risks are priced separately for our sample of seven emerging markets. The empirical evidence also suggests that although statistically significant, local currency risk is on average smaller than domestic market risk but it increases substantially during crises periods, when it can be almost as large as market risk. Disentangling these two factors is thus important in tests of international asset pricing for emerging markets.     

Ambiguity and asset pricing: An empirical investigation for an emerging market

This study explores the impact of ambiguity on returns of both individual stocks and stock portfolios in an emerging market setting. First, an ambiguity index is derived and then the sensitivity of stock returns to ambiguity is analyzed while controlling for the other risk factors commonly cited in the literature. Results show that stocks with a high (low) sensitivity to ambiguity generate higher (lower) excess returns. These results are intuitive in the sense that investors seem to ask for lower returns from those stocks that serve as a natural hedge against ambiguity. Our findings are also in line with the earlier studies that provide similar evidence from the US stock markets.     

The Variation of Economic Risk Premiums in Real Estate Returns

We examine the predictable components of returns on stocks, bonds, and real estate investment trusts (REITs). We employ a multiple-beta asset pricing model and find that there are varying degrees of predictability among stocks, bonds, and REITs. Furthermore, we find that most of the predictability of returns is associated with the economic variables employed in the asset pricing model. The stock market risk premium is highly important in capturing the predictable variation in stock portfolios, and the bond market risk premiums (term and risk structure of interest rates) are important in capturing the predictable variation in bond portfolios. For REITs, however, both the stock and bond market risk premiums capture the predictable variation in returns. REITs have comparable return predictability to stock portfolios. We conclude that there is an important economic risk premium for REITs that are not captured by traditional multiple-beta asset pricing models.     

Asset pricing in China's domestic stock markets: Is there a logic?

China's stock markets have grown rapidly since their inception and have become an increasingly important emerging market for international investors. However, there are few systematic studies on how asset prices are formed in Chinese domestic equity markets; popular financial media even depict the market as irrational. In this paper, we study the asset pricing mechanism in the nascent Chinese stock markets, with the objective of identifying variables that capture the cross-sectional variation in average stock returns. We focus on the effects of various market imperfections in China. We find that while the market risk (beta) is not priced, there is a significantly negative relationship between firm-specific risk and expected returns. Chinese investors are willing to pay a significant premium for more liquid stocks or for dividend-paying stocks. Furthermore, investors value local A-shares more if there are offshore counterparts (e.g., B- and H-shares) for foreigners, implying that a Chinese firm with a foreign shareholder base has a lower cost of capital, ceteris paribus. Lastly, as with U.S. and other mature markets, firm size and the book-to-market ratio are systematically related to stock returns. Given market imperfections, stocks are priced rather rationally in China, despite the widespread perception to the contrary.     

Do the crude oil futures of the Shanghai International Energy Exchange improve asset allocation of Chinese petrochemical-related stocks?

The Shanghai International Energy Exchange (INE) facilitates both local and international investment in Chinese petrochemical-related stocks through local crude oil futures. This study investigates whether the Chinese emerging market can better aid investors' risk hedging and asset allocation compared to two major international developed markets–the Brent and West Texas Intermediate (WTI) crude oil futures markets—and examines the pairwise risk hedging effects and multi-asset allocation performance of INE and petrochemical-related stocks. The results show that INE has higher hedge effectiveness than Brent and WTI under pairwise hedging. Further, in multi-asset allocation, the portfolios containing INE outperform other portfolios. Overall, INE results in a better diversification effect and volatility reduction than the use of WTI crude oil futures to construct multi-asset allocation with Chinese petrochemical-related stocks. However, INE performance is inferior to Brent's in terms of constructing portfolios with oil or energy stocks. Finally, our results are robust to the five factors proposed by Fama and French (2015) in asset pricing.     

Interaction of size,book‐to‐market and momentum effects in Australia

This study seeks to disentangle the effects of size, book‐to‐market and momentum on returns. Initial results show that each characteristic has a role in explaining returns, but that there is interaction between size and momentum, as well as between size and book‐to‐market. Three key findings emerge. First, the size premium is the strongest, particularly in the loser portfolios. Second, the value premium is generally limited to the smallest portfolios. Third, the momentum premium is evident for the large‐ and middle‐sized portfolios, but loser stocks significantly outperform winner stocks in the smallest size portfolio. When these interactions are controlled with multivariate regression, we find a significant negative average relation between size and returns, a significant positive average relation between book‐to‐market and returns, and a significant positive average relation between momentum and returns.     

Comoment risk and stock returns

We estimate investable comoment equity risk premiums for the US markets. The stock's contribution to the asymmetry and the fat tails of the market portfolio's payoff are priced into a coskewness premium and a cokurtosis premium. We construct zero-investment strategies that are long and short in coskewness and cokurtosis equity risks; we infer from the spread the returns attached to a unit exposure to US equity coskewness and cokurtosis. The coskewness and cokurtosis premiums present positive monthly average returns of 0.27% and 0.14% from January 1959 to December 2011. Comoment risks appear to be significantly priced within the US stock market and display significant explanatory power regarding the US size and book-to-market effects. The premiums do not subsume, but rather complement the empirical capital asset pricing model. Our analysis relies on data collected from CRSP (Chicago Research Center for Security Prices) over December 1955 to December 2011. To our knowledge, the paper is the first to propose investable higher-moment risk factors over such an extensive time period.     

Do foreign investors insulate firms from local shocks? Evidence from the response of investable firms to monetary policy

Extant research shows that stock returns of investable firms are highly sensitive to foreign market and global information shocks, suggesting that having foreign investors might insulate investable firms from shocks to local fundamentals. Examining 24 emerging markets, we find that both investable and non-investable firms are sensitive to local monetary policy shocks. This allays the concern that emerging-market opening reduces the efficacy of local monetary policy. We also find that in 11 countries (46% of our country-sample), investable firms are more sensitive to local shocks than non-investable firms. Differences in leverage, stock liquidity, size, domestic product-market exposure, or industry cyclicality do not drive this finding.     

Accrual quality,skill, and the cross-section of mutual fund returns

We use returns of actively managed mutual funds to document the link between accrual quality (AQ) and systematic (priced) risk. Despite compelling theoretical arguments, prior research finds no evidence that poor AQ commands a risk premium in the cross-section of realized stock returns. We argue that the previously obtained premium estimates are biased downward because, for a large portion of poor AQ stocks, higher expected returns are offset by the news of deteriorating fundamentals. We suggest that skilled mutual fund managers should be able to either avoid investing in stocks with deteriorating fundamentals or assign them lower portfolio weights. As a consequence, returns on their portfolios should better reflect the expected AQ risk premium. Our empirical evidence is consistent with these predictions.     

The cross-section of stock returns in frontier emerging markets

We are the first to investigate the cross-section of stock returns in the new emerging equity markets, the so-called frontier emerging markets. Our unique survivorship-bias free data set consists of more than 1400 stocks over the period 1997 to 2008 and covers 24 of the most liquid frontier emerging markets. The major benefit of using individual stock characteristics is that it allows us to investigate whether return factors that have been documented in developed countries also exist in these markets. We document the presence of economically and statistically significant value and momentum effects, and a local size effect. Our results indicate that the value and momentum effects still exist when incorporating conservative assumptions of transaction costs. Additionally, we show that value, momentum, and local size returns in frontier markets cannot be explained by global risk factors.     

A macroeconomic hedge portfolio and the cross section of stock returns

We use a stock's returns on days when important macroeconomic news is released to form a hedge portfolio, which is long (short) in stocks which have a sensitive (insensitive) reaction to the surprise component of the macroeconomic news. This macroeconomic hedge portfolio (MHP) earns a risk premium of about 5% p.a. over time and a similar premium when used as a risk factor in an asset pricing model. This premium can be interpreted as a cost of an insurance against unexpected changes in an investor's marginal utility. We show that risk premiums associated with the MHP are estimated with a higher precision than traditional macroeconomic tracking portfolios. Furthermore, when the MHP is present in a common factor model, risk factors like high minus low lose much of their ability to explain the cross section of stock returns.     

The investment value of the value premium

Value investment strategies are premised on research that value stocks outperform growth stocks. However, the research findings are dependent on the portfolio classification method that is used to sort stocks using the attributes of size and book-to-market ratios. Different stock markets contain different distributions of stocks, and in many markets, illiquidity concerns combined with a lack of investment scale, effectively create barriers to practical portfolio formations that align with the research. This study conducts a case study on one such market (Australia) and demonstrates that different methods of portfolio formation lead to different conclusions. For example, previous studies in Australia find evidence of the value premium only being present in the largest stocks, in contrast to the results from the US market. However, we find a value premium that is systematic across all size categories and generally increases inversely with size. Further, we find the well-documented size premium largely disappears once portfolios are formed that better represent feasible investment sets and once ‘penny dreadfuls’ are removed. Finally, asset pricing tests support the existence of a value premium in Australian stock returns when a more appropriate portfolio formation method is employed.     

Liquidity risk and stock returns around the world

The recent global financial crisis demonstrates that market liquidity is a prominent systematic risk globally. We find that local liquidity risk, in addition to the local market, value and size factors, demands a systematic premium across stocks in 11 developed markets. This local pricing premium is smaller in countries where the country-level corporate boards are more effective and where there are less insider trading activities. We also discover that global liquidity risk is a significant pricing factor across all developed country market portfolios after controlling for global market, value, and size factors. The contribution of this risk to the return on a country market portfolio is economically and statistically significant within and across regions.     

The cross-section and time series of stock and bond returns

Bond factors which predict future U.S. economic activity at business cycle horizons are priced in the cross-section of U.S. stock returns. High book-to-market stocks have larger exposures to these bond factors than low book-to-market stocks, because their cash flows are more sensitive to the business cycle. Because of this new nexus between stock and bond markets, a parsimonious three-factor dynamic no-arbitrage model can be used to jointly price book-to-market-sorted portfolios of stocks and maturity-sorted bond portfolios, while reproducing the time-series variation in expected bond returns. The business cycle itself is a priced state variable in stock and bond markets.     

Does Risk Seeking Drive Stock Prices? A Stochastic Dominance Analysis of Aggregate Investor Preferences and Beliefs

We use various stochastic dominance criteria that account for(local) risk seeking to analyze market portfolio efficiencyrelative to benchmark portfolios formed on market capitalization,book-to-market equity ratio and price momentum. Our resultssuggest that reverse S-shaped utility functions with risk aversionfor losses and risk seeking for gains can explain stock returns.The results are also consistent with a reverse S-shaped patternof subjective probability transformation. The low average yieldon big caps, growth stocks, and past losers may reflect investors’twin desire for downside protection in bear markets and upsidepotential in bull markets.     

Small caps in international equity portfolios: the effects of variance risk

We show that predictable covariances between means and variances of stock returns may have a first order effect on portfolio composition. In an international asset menu that includes both European and North American small capitalization equity indices, we find that a three-state, heteroskedastic regime switching VAR model is required to provide a good fit to weekly return data and to accurately predict the dynamics in the joint density of returns. As a result of the non-linear dynamic features revealed by the data, small cap portfolios become riskier in bear markets, i.e., display negative co-skewness with other stock indices. Because of this property, a power utility investor ought to hold a well-diversified portfolio, despite the high risk premium and Sharpe ratios offered by small capitalization stocks. On the contrary, small caps command large optimal weights when the investor ignores variance risk, by incorrectly assuming joint normality of returns.      

Market timing for the individual investor: Using the predictability of long-horizon stock returns to enhance portfolio performance

Recent research indicates that dividend yield and earnings-price ratio can partially predict long-horizon stock returns. We examine whether individual investors can successfully construct timing portfolios based on either of these variables or a measure of the expected market risk premium. The out-of-sample tests in this study require that investors rely only on information that was available at the time of the market-timing decision. Timing portfolios based on the market risk premium show the strongest ability to time the market. We present an economic rationale for the results that is consistent with efficient markets.     

Multiscale stock-bond correlation: Implications for risk management

This paper examines the multiscale return correlation between the stocks and government bonds of different maturities returns in 25 countries. The analysis reveals that developed markets correlations are generally negative at the first time-scale and move in a positive direction at higher scales. This contrasts with emerging markets, where the correlation tends to be positive throughout. Thus, the results support a greater flight-to-safety effect in developed markets. Further evidence highlights the ability of the correlation to produce portfolios with a lower VaR. Results support this at longer time-scales and for both developed and emerging markets. The results here demonstrate the importance of accounting for time-scales in modelling the stock-bond correlation and in constructing portfolios.     

An international CAPM for partially integrated markets: Theory and empirical evidence

This article proposes a theoretical testable capital asset pricing model for partially segmented markets. We establish that if some investors do not hold all international assets because of direct and/or indirect barriers, the world market portfolio is not efficient and the traditional international CAPM must be augmented by a new factor reflecting the local risk undiversifiable internationally. We also introduce a suitable framework to test this model empirically. Using a sample of six emerging markets and three mature markets, we find that the degree of stock market integration varies through time and that most of the sample emerging markets have become more integrated in the recent years. The local risk premium for emerging markets represents the most important component of the total risk premium, but its relative importance has decreased recently. Differently, the total risk premium for developed countries is largely driven by global factors.