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CAPM Tests and Alternative Factor Portfolio Composition.Getting the Alpha’s Right

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  • L. de Moor
  • P. Sercu

Abstract

CAPWe show that the results of a CAPM test are quite sensitive to the details of the test design. Especially crucial are the aspects related to the weight one gives to small, low-reputation stocks when constructing both the factor portfolios and the test or style portfolios whose returns are to be explained. To fit our observed returns we need to redesign the size and distress factor portfolios into two factor portfolios each, one for extremely small or distressed stocks relative to nonextreme stocks, and one for moderately small or distressed stocks versus larger or growth compamies. This alternative model does a better job in pricing stocks, both in the US and internationally, than the standard four-factor CAPM model with factor portfolios designed following Fama and French ((1992), (1993), (1995), (1996a), (1996b), (1998), (2000)), Carhart (1997), Jegadeesh and Titman (1993) and Rouwenhorst (1999).

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Bibliographic Info

Article provided by Katholieke Universiteit Leuven, Faculteit Economie en Bedrijfswetenschappen in its journal Review of Business and Economics.

Volume (Year): XLIX (2004)
Issue (Month): 4 ()
Pages: 789-846

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Handle: RePEc:ete:revbec:20040408

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Postal: Naamsestraat 69, 3000 Leuven
Web page: http://www.econ.kuleuven.be
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  1. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-65, June.
  2. Eugene F. Fama & Kenneth R. French, 1998. "Value versus Growth: The International Evidence," Journal of Finance, American Finance Association, vol. 53(6), pages 1975-1999, December.
  3. Bodnar, Gordon M. & Gentry, William M., 1993. "Exchange rate exposure and industry characteristics: evidence from Canada, Japan, and the USA," Journal of International Money and Finance, Elsevier, vol. 12(1), pages 29-45, February.
  4. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
  5. James L. Davis & Eugene F. Fama & Kenneth R. French, 2000. "Characteristics, Covariances, and Average Returns: 1929 to 1997," Journal of Finance, American Finance Association, vol. 55(1), pages 389-406, 02.
  6. Solnik, Bruno, 1983. " International Arbitrage Pricing Theory," Journal of Finance, American Finance Association, vol. 38(2), pages 449-57, May.
  7. Jorion, Philippe, 1990. "The Exchange-Rate Exposure of U.S. Multinationals," The Journal of Business, University of Chicago Press, vol. 63(3), pages 331-45, July.
  8. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
  9. K. Geert Rouwenhorst, 1999. "Local Return Factors and Turnover in Emerging Stock Markets," Journal of Finance, American Finance Association, vol. 54(4), pages 1439-1464, 08.
  10. Banz, Rolf W., 1981. "The relationship between return and market value of common stocks," Journal of Financial Economics, Elsevier, vol. 9(1), pages 3-18, March.
  11. Solnik, Bruno H, 1977. "Testing International Asset Pricing: Some Pessimistic Views," Journal of Finance, American Finance Association, vol. 32(2), pages 503-12, May.
  12. Fama, Eugene F & French, Kenneth R, 1996. " The CAPM Is Wanted, Dead or Alive," Journal of Finance, American Finance Association, vol. 51(5), pages 1947-58, December.
  13. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. " Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March.
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Cited by:
  1. Sercu, Piet & Van Pée, Rosanne, 2008. "Estimating the costs of international equity investments," Open Access publications from Katholieke Universiteit Leuven urn:hdl:123456789/183150, Katholieke Universiteit Leuven.
  2. Sercu, Piet & Vanpee, R, 2007. "The value of clean hands: Public policy and international asset allocation," Open Access publications from Katholieke Universiteit Leuven urn:hdl:123456789/120464, Katholieke Universiteit Leuven.
  3. Sercu, Piet & Vanpee, R, 2006. "Estimating the costs of international equity investments," Open Access publications from Katholieke Universiteit Leuven urn:hdl:123456789/230069, Katholieke Universiteit Leuven.
  4. Sercu, Piet & Vanpee, R, 2007. "Home bias in international equity portfolios: a review," Open Access publications from Katholieke Universiteit Leuven urn:hdl:123456789/175483, Katholieke Universiteit Leuven.

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