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Robust Tests of the Lower Partial Moment Asset Pricing Model in Emerging Markets

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  • Iqbal, Javed
  • Brooks, Robert
  • Galagedera, Don UA

Abstract

This paper tests and compares the CAPM of Black (1972) and the Mean Lower Partial Moment (MLPM) Capital Asset Pricing Model of Bawa and Lindenberg (1977) and Harlow and Rao (1989) in the context of emerging markets. It is well known that returns in emerging markets are non-normal and have greater predictability than in the developed markets. Considering these stylized facts the paper extends the Harlow-Rao Likelihood Ratio test of a Black (1972) type version of the MLPM model and develops a Wald test that allow for non-normality of the returns. The paper also formulates a GMM test that is valid under the conditions of heteroskedasticity and serial dependence. For the test of the CAPM hypothesis against the MLPM alternative the paper remedies an econometric problem of testing in presence of a nuisance parameter. In the empirical application on an emerging market data it is shown that the conclusion on the validity of the asset pricing model are reversed when the correct p-values obtained through the bootstrap test are employed. We demonstrate that the empirical results appear to support both the Black version of the CAPM and the MLPM model when performed against unspecified alternative but the CAPM is supported when an MLPM alternative is specified.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 25349.

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Date of creation: May 2007
Date of revision: May 2007
Handle: RePEc:pra:mprapa:25349

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Keywords: Asset Pricing; Mean-Lower Partial Moments; Emerging Markets;

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  1. Hwang, Soosung & Pedersen, Christian S., 2004. "Asymmetric risk measures when modelling emerging markets equities: evidence for regional and timing effects," Emerging Markets Review, Elsevier, vol. 5(1), pages 109-128, March.
  2. Chou, Pin-Huang, 2000. "Alternative Tests of the Zero-Beta CAPM," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 23(4), pages 469-93, Winter.
  3. James G. MacKinnon, 2002. "Bootstrap inference in econometrics," Canadian Journal of Economics, Canadian Economics Association, vol. 35(4), pages 615-645, November.
  4. Groenewold, Nicolaas & Fraser, Patricia, 2001. "Tests of asset-pricing models: how important is the iid-normal assumption?," Journal of Empirical Finance, Elsevier, vol. 8(4), pages 427-449, September.
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  9. Andrews, Donald W K & Ploberger, Werner, 1994. "Optimal Tests When a Nuisance Parameter Is Present Only under the Alternative," Econometrica, Econometric Society, vol. 62(6), pages 1383-1414, November.
  10. Campbell R. Harvey, 1994. "Predictable Risk and Returns in Emerging Markets," NBER Working Papers 4621, National Bureau of Economic Research, Inc.
  11. Jean-Marie Dufour & Lynda Khalaf & Marie-Claude Beaulieu, 2003. "Exact Skewness-Kurtosis Tests for Multivariate Normality and Goodness-of-Fit in Multivariate Regressions with Application to Asset Pricing Models," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 65(s1), pages 891-906, December.
  12. Salomons, Roelof & Grootveld, Henk, 2003. "The equity risk premium: emerging vs. developed markets," Emerging Markets Review, Elsevier, vol. 4(2), pages 121-144, June.
  13. Garcia, Rene, 1998. "Asymptotic Null Distribution of the Likelihood Ratio Test in Markov Switching Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(3), pages 763-88, August.
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  18. Jobson, J. D. & Korkie, Bob, 1982. "Potential performance and tests of portfolio efficiency," Journal of Financial Economics, Elsevier, vol. 10(4), pages 433-466, December.
  19. Geert Bekaert & Campbell R. Harvey, 1994. "Time-Varying World Market Integration," NBER Working Papers 4843, National Bureau of Economic Research, Inc.
  20. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
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  22. Bawa, Vijay S., 1975. "Optimal rules for ordering uncertain prospects," Journal of Financial Economics, Elsevier, vol. 2(1), pages 95-121, March.
  23. Harlow, W. V. & Rao, Ramesh K. S., 1989. "Asset Pricing in a Generalized Mean-Lower Partial Moment Framework: Theory and Evidence," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(03), pages 285-311, September.
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