Multi-Factor asset pricing model in Iranian Capital Market

Document Type : Original Article

Authors

1 Assistant Prof., Department of Financial Management and Insurance, University of Tehran, Tehran, Iran.

2 Master's student in Financial Management, University of Tehran, Tehran, Iran

3 Master's student in Financial Management, University of Tehran, Tehran, Iran.

Abstract

Eight-factor pricing model of Skocˇir and Loncˇarski (2018) is a development of Fama and French (2016). They attempt to improve the explanatory power of the model by adding three factors; default risk, liquidity and momentum, in response to some anomalies of the model. Findings show that explanatory power of the model depends highly on variable selection. Efficiency of the model has not been approved in the mentioned confidence interval. But, evidence of the new factors` power and their impact on improvement of the model shows that in combination with 5- factor model, momentum has better performance and default has the worst performance. In addition, through combination of 2 factors, intercept analysis implies that combination of liquidity and momentum leads to a better performance.

Highlights

1. Amihud, Y. (2002). liquidity and Stock Returns: Cross-Section and Timeseries Effects. Journal of Financial Markets, 5, pp. 31-56.

2. Badri, A. & Davaloo, M. & Aghajani, F. (2018). Source of momentum generation; Evidence on how to adjust risk. Journal of Financial Management Perspective,23(8), 9-31. (in Persian)

3. Banz, R. W. (1981). The relative efficiency of various portfolios: Some further evidence: Discussio. Journal of Finance, 35(2): 663– 682.

4. Bharath, S. T. and Shumway, T. (2005). “Forecasting default with the KMV–Merton model”, Working Paper, University of Michigan.

5. Carhart, M. (1997). On persistence in mutual fund performance. Journal of Finance, 52, 57–82.

6. Cohen, R.B., Gompers, P.A., Vuolteenaho, T. (2002). Who underreacts to cash-flow news? evidence from trading between individuals and institutions. Journal of Financial Economics, 66 (2), 409–462.

7.. Eivazlu, R, Ghahramani, A & Ajami, A. (2017). Analyzing the Performance of Fama and French Five-factor Model Using GRS Test. Journal of Financial Research, 70(22), 691-714

8. Eslami Bidgoli, G. & Kimiyagari, A. & Eskandari, M. (2008). Test of the FamaFrench Three-Factor Model in Tehran Stock Exchange. Journal of Financial Research, 9(2), 61-82. (in Persian)

9. Fadaeenejhad, M, & Eivazlu, R. (2006). Investigating the value premium in the Tehran Stock Exchange and its position in the pricing of capital assets. Journal of Financial Research, 22(8), 33-46 (in Persian)

10. Farhadi, R., Akhoundi, O., Mehr Avar, H. (2019). Explaining the Relationship between Herding Behavior and Momentum with Stock Returns: Evidence from the Iran Capital Market. Journal of Financial Management Perspective, 26(9), 121-145 (in persian)

11. Fallahshams, M.& Hahemi, N. & Heidari, A. (2011).  Investigating the Relationship between Liquidity Risk and Price in Tehran Stock Exchange. Quarterly Financial Engineering and Securities Management, 2(9), 207-227. (in Persian)

12. Fama, E.F., French, K.R. (1992). The cross-section of expected stock returns. Journal of Finance, 47 (2), 427–465.

13.Fama, E. & French, K. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33(1), 3–56.

14. Fama, E.F., French, K.R. (1995). Size and book-to-market factors in earnings and returns. Journal of Finance, 50 (1), 131–155.

15. Fama, E.F., French, K.R. (2008). Dissecting anomalies. Journal of Finance, 63 (4), 1653–1678.

16. Fama, E.F., French, K.R., )2016(a. Choosing Factors. SSRN Scholarly Paper ID 2668236, Social Science Research Network, Rochester, NY.

17. Fama, E.F., French, K.R., )2016(b. Dissecting anomalies with a five-factor model. Rev. Financ. Stud. 29 (1), 69–103.

18. Gibbons, M.R., Ross, S.A., Shanken, J., 1989. A test of the efficiency of a given portfolio. Econ.: J. Econ. Soc., 1121–1152

19. Haugen, R.A., Baker, N.L. (1996). Commonality in the determinants of expected stock returns. Journal of Financial Economics, 41 (3), 401–439.

20. Hezbi, H., Salehi, A., Salehi, B. (2014). Fama and French five-factor model: A new model for measurement Expected stock returns. Accounting and auditing research,4(4), 109- 120 (in persian)

21. Hou, K., Xue, C., Zhang, L. (2015). Digesting anomalies: an investment approach. Review of Financial Studies, 28 (3), 650–705.

22. KMV Corporation (1997). “Modeling Default Risk (Technical Document)”, http://www.kmv.com.

23. Lintner, J. (1965). The valuation of risk assets and the selection of risk investments in stock portfolios and capital budgets. Review Economics and Statistics, 47, 13–37.

24. Markowitz, H. (1952). Portfolio Selection. The Journal of Finance, 7(1), 77-91.

25. Merton, R.C. (1974). On the pricing of corporate debt: the risk structure of interest rates. Journal of Finance, 29 (2), 449–470.

26. Mohammad Tabar Kasgari, F., Dehghan, A., Hashemi Farasha, A. (2018).  Relationship between Corporate Characteristics and Systematic Risk in Tehran Stock Exchange Using the Fama and French Three-Factor Model. Journal of Financial Management Strategy, 2(8), 177-196

27. Moradi, M., Kamari, J., Dahi, F. (2015). The Impact of Profitability and Investment Factors on Stock Return (Fama French Five Factor Model). Journal of Financial Management Perspective, 11(5), 53-78

28. Novy-Marx, R. (2013). The other side of value: The gross profitability premium. Journal of Financial Economics, 108, 1–28.

29. Pástor, L., Stambaugh, R. (2003). Liquidity risk and expected stock returns. Journal of Political Economy, 111, 642–685

30. Pourzamani, Z. & Bashiri, A. (2013). Test the Karhart model to predict expected returns by growth and value stocks. Journal of Financial Engineering and Securities Management,16(4), 93-107. (in persian)

31. Rosenberg, B., Reid, K., Lanstein, R., 1985. Persuasive evidence of market inefficiency. J. Portfolio Manage. 11 (3), 9–16.

32. Rostami, M, & Rezae Moghadam, A. (2013). Assessing long-term IPO return by Fama-French model approach and emphasise on liquidity. Journal of Human Resoure. 81, 120-137 (in persian)

33. Sadegh Sharif, S. & Akbarosadat, M. (2011). Earning Management & the Long-Run Market Performance of Initial Public Offerings: Evidences from Tehran Stock Exchange. Journal of Financial Research, 13(32), 57-72. (in Persian) 

34. Sharpe, William F. (1964). Capital asset prices: A theory of market equilibrium under conditions of risk. Journal of Finance, 19, 425–442.

35. Skocˇir, M., Loncˇarski, I. (2018). Multi-factor asset pricing models: Factor construction choices and the revisit of pricing factors. Journal of International Financial Markets, Institutions & Money, 55, 65-80.

36. Stattman, D., 1980. Book values and stock returns. Chicago MBA: J. Select. Papers 4 (1), 25–45.

37. Titman, S., Wei, K., Xie, F. (2004). Capital investments and stock returns. Journal of Financial and Quantitative Analysis, 39, 677–700.

38. Vassalou, M., Xing, Y., 2004. Default risk in equity returns. J. Finan. 59 (2), 831–868.

Keywords

References

1. Amihud, Y. (2002). liquidity and Stock Returns: Cross-Section and Timeseries Effects. Journal of Financial Markets, 5, pp. 31-56.
2. Badri, A. & Davaloo, M. & Aghajani, F. (2018). Source of momentum generation; Evidence on how to adjust risk. Journal of Financial Management Perspective,23(8), 9-31. (in Persian)
3. Banz, R. W. (1981). The relative efficiency of various portfolios: Some further evidence: Discussio. Journal of Finance, 35(2): 663– 682.
4. Bharath, S. T. and Shumway, T. (2005). “Forecasting default with the KMV–Merton model”, Working Paper, University of Michigan.
5. Carhart, M. (1997). On persistence in mutual fund performance. Journal of Finance, 52, 57–82.
6. Cohen, R.B., Gompers, P.A., Vuolteenaho, T. (2002). Who underreacts to cash-flow news? evidence from trading between individuals and institutions. Journal of Financial Economics, 66 (2), 409–462.
7.. Eivazlu, R, Ghahramani, A & Ajami, A. (2017). Analyzing the Performance of Fama and French Five-factor Model Using GRS Test. Journal of Financial Research, 70(22), 691-714
8. Eslami Bidgoli, G. & Kimiyagari, A. & Eskandari, M. (2008). Test of the FamaFrench Three-Factor Model in Tehran Stock Exchange. Journal of Financial Research, 9(2), 61-82. (in Persian)
9. Fadaeenejhad, M, & Eivazlu, R. (2006). Investigating the value premium in the Tehran Stock Exchange and its position in the pricing of capital assets. Journal of Financial Research, 22(8), 33-46 (in Persian)
10. Farhadi, R., Akhoundi, O., Mehr Avar, H. (2019). Explaining the Relationship between Herding Behavior and Momentum with Stock Returns: Evidence from the Iran Capital Market. Journal of Financial Management Perspective, 26(9), 121-145 (in persian)
11. Fallahshams, M.& Hahemi, N. & Heidari, A. (2011).  Investigating the Relationship between Liquidity Risk and Price in Tehran Stock Exchange. Quarterly Financial Engineering and Securities Management, 2(9), 207-227. (in Persian)
12. Fama, E.F., French, K.R. (1992). The cross-section of expected stock returns. Journal of Finance, 47 (2), 427–465.
13.Fama, E. & French, K. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33(1), 3–56.
14. Fama, E.F., French, K.R. (1995). Size and book-to-market factors in earnings and returns. Journal of Finance, 50 (1), 131–155.
15. Fama, E.F., French, K.R. (2008). Dissecting anomalies. Journal of Finance, 63 (4), 1653–1678.
16. Fama, E.F., French, K.R., )2016(a. Choosing Factors. SSRN Scholarly Paper ID 2668236, Social Science Research Network, Rochester, NY.
17. Fama, E.F., French, K.R., )2016(b. Dissecting anomalies with a five-factor model. Rev. Financ. Stud. 29 (1), 69–103.
18. Gibbons, M.R., Ross, S.A., Shanken, J., 1989. A test of the efficiency of a given portfolio. Econ.: J. Econ. Soc., 1121–1152
19. Haugen, R.A., Baker, N.L. (1996). Commonality in the determinants of expected stock returns. Journal of Financial Economics, 41 (3), 401–439.
20. Hezbi, H., Salehi, A., Salehi, B. (2014). Fama and French five-factor model: A new model for measurement Expected stock returns. Accounting and auditing research,4(4), 109- 120 (in persian)
21. Hou, K., Xue, C., Zhang, L. (2015). Digesting anomalies: an investment approach. Review of Financial Studies, 28 (3), 650–705.
22. KMV Corporation (1997). “Modeling Default Risk (Technical Document)”, http://www.kmv.com.
23. Lintner, J. (1965). The valuation of risk assets and the selection of risk investments in stock portfolios and capital budgets. Review Economics and Statistics, 47, 13–37.
24. Markowitz, H. (1952). Portfolio Selection. The Journal of Finance, 7(1), 77-91.
25. Merton, R.C. (1974). On the pricing of corporate debt: the risk structure of interest rates. Journal of Finance, 29 (2), 449–470.
26. Mohammad Tabar Kasgari, F., Dehghan, A., Hashemi Farasha, A. (2018).  Relationship between Corporate Characteristics and Systematic Risk in Tehran Stock Exchange Using the Fama and French Three-Factor Model. Journal of Financial Management Strategy, 2(8), 177-196
27. Moradi, M., Kamari, J., Dahi, F. (2015). The Impact of Profitability and Investment Factors on Stock Return (Fama French Five Factor Model). Journal of Financial Management Perspective, 11(5), 53-78
28. Novy-Marx, R. (2013). The other side of value: The gross profitability premium. Journal of Financial Economics, 108, 1–28.
29. Pástor, L., Stambaugh, R. (2003). Liquidity risk and expected stock returns. Journal of Political Economy, 111, 642–685
30. Pourzamani, Z. & Bashiri, A. (2013). Test the Karhart model to predict expected returns by growth and value stocks. Journal of Financial Engineering and Securities Management,16(4), 93-107. (in persian)
31. Rosenberg, B., Reid, K., Lanstein, R., 1985. Persuasive evidence of market inefficiency. J. Portfolio Manage. 11 (3), 9–16.
32. Rostami, M, & Rezae Moghadam, A. (2013). Assessing long-term IPO return by Fama-French model approach and emphasise on liquidity. Journal of Human Resoure. 81, 120-137 (in persian)
33. Sadegh Sharif, S. & Akbarosadat, M. (2011). Earning Management & the Long-Run Market Performance of Initial Public Offerings: Evidences from Tehran Stock Exchange. Journal of Financial Research, 13(32), 57-72. (in Persian) 
34. Sharpe, William F. (1964). Capital asset prices: A theory of market equilibrium under conditions of risk. Journal of Finance, 19, 425–442.
35. Skocˇir, M., Loncˇarski, I. (2018). Multi-factor asset pricing models: Factor construction choices and the revisit of pricing factors. Journal of International Financial Markets, Institutions & Money, 55, 65-80.
36. Stattman, D., 1980. Book values and stock returns. Chicago MBA: J. Select. Papers 4 (1), 25–45.
37. Titman, S., Wei, K., Xie, F. (2004). Capital investments and stock returns. Journal of Financial and Quantitative Analysis, 39, 677–700.
38. Vassalou, M., Xing, Y., 2004. Default risk in equity returns. J. Finan. 59 (2), 831–868.

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