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The cross-section of stock returns : evidence from emerging markets

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  • Claessens, Stijn
  • Dasgupta, Susmita
  • Glen, Jack

Abstract

Cross-sectional tests of asset returns have a long tradition in finance. The often-used capital asset pricing model (CAPM) and the arbitrage pricing theory both imply cross-sectional relationships between individual asset returns and other factors, and tests of those models have done much to increase understanding of how markets price risk. But much about the way assets are priced remains unclear. After much testing, numerous empirical anomalies about the CAPM cast doubt on the central hypothesis of that theory: that on a cross-sectional basis a positive relationship exists between asset returns and assets'relative riskiness as measured by their Bs (beta being the ratio of the covariance of an asset's return with the market return to the variance of the market return). As tenuous as the relationship between B and returns may be, other risk factors apparently influence U.S. equity market returns significantly: market capitalization (or size), earnings-price ratios, and book-to-market value of equity ratios. Once these factors are included as explanatory variables in the cross-sectional model, the relationship between B and returns disappears. Much"international"empirical work has focused on more developed markets, especially Japan and the United Kingdom, with some evidence from other European markets as well. The international evidence largerly confirms the hypothesis that other factors besides B are important in explaining asset returns. The authors expand the empirical evidence on the nature of asset returns by examining the cross-sectional pattern of returns in the emerging markets. Using data from the International Finance Corporation for 19 developing country markets, they examine the effect on asset returns of several risk factors in addition to B. They find that, in addition to B, two factors - size and trading volume - have significant explanatory power in a number of these markets. Dividend yield and earnings-price ratio are also important, but in slightly fewer markets. For several of the markets studied, the relationship between all four of these variables and returns is contrary to the relationship documented for U.S. and Japanese markets. In several countries, exchange-rate risk is a significant factor. With independent new empirical evidence introduced into the asset-pricing debate, future research must now cope with the idea that any theory hoping to explain asset pricing in all markets must explain how factors can be priced differently simply by crossing an international border. Is it market microstructure that causes these substantial differences? Or (perhaps more likely) do regulatory and tax regimes force investors to behave differently in various countries? As a final hypothesis, can any of these results be attributed to the segmentation or increasing integration of financial markets? The authors offer little evidence on these questions but hope their results will spur further work on the cross-sectional relationship of markets and of assets in testing asset pricing theories.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1505.

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Date of creation: 30 Sep 1995
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Handle: RePEc:wbk:wbrwps:1505

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Keywords: Banks&Banking Reform; Payment Systems&Infrastructure; Economic Theory&Research; Markets and Market Access; International Terrorism&Counterterrorism; Economic Theory&Research; Access to Markets; Markets and Market Access; Banks&Banking Reform; Financial Intermediation;

References

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  1. Dumas, Bernard & Solnik, Bruno, 1995. " The World Price of Foreign Exchange Risk," Journal of Finance, American Finance Association, vol. 50(2), pages 445-79, June.
  2. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
  3. Harvey, Campbell R, 1995. "The Risk Exposure of Emerging Equity Markets," World Bank Economic Review, World Bank Group, vol. 9(1), pages 19-50, January.
  4. Litzenberger, Robert H & Ramaswamy, Krishna, 1982. " The Effects of Dividends on Common Stock Prices: Tax Effects or Information Effects?," Journal of Finance, American Finance Association, vol. 37(2), pages 429-43, May.
  5. Reinganum, Marc R., 1981. "A New Empirical Perspective on the CAPM," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 16(04), pages 439-462, November.
  6. 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.
  7. Chan, Louis K C & Hamao, Yasushi & Lakonishok, Josef, 1991. " Fundamentals and Stock Returns in Japan," Journal of Finance, American Finance Association, vol. 46(5), pages 1739-64, December.
  8. Christie, W. G. & Huang, R. D., 1994. "The changing functional relation between stock returns and dividend yields," Journal of Empirical Finance, Elsevier, vol. 1(2), pages 161-191, January.
  9. Claessens, Stijn & Dasgupta, Susmita & Glen, Jack, 1995. "Return Behavior in Emerging Stock Markets," World Bank Economic Review, World Bank Group, vol. 9(1), pages 131-51, January.
  10. Lo, Andrew W. (Andrew Wen-Chuan) & MacKinlay, Archie Craig, 1955-, 1989. "Data-snooping biases in tests of financial asset pricing models," Working papers 3020-89., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  11. Black, Fischer & Scholes, Myron, 1974. "The effects of dividend yield and dividend policy on common stock prices and returns," Journal of Financial Economics, Elsevier, vol. 1(1), pages 1-22, May.
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Citations

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Cited by:
  1. K. Rouwenhorst, 1998. "Local Return Factors and Turnover in Emerging Stock Markets," Yale School of Management Working Papers ysm97, Yale School of Management, revised 01 Mar 2001.
  2. John Fernald & John H. Rogers, 1998. "Puzzles in the Chinese stock market," International Finance Discussion Papers 619, Board of Governors of the Federal Reserve System (U.S.).
  3. Bagella, Michele & Becchetti, Leonardo & Carpentieri, Andrea, 2000. ""The first shall be last". Size and value strategy premia at the London Stock Exchange," Journal of Banking & Finance, Elsevier, vol. 24(6), pages 893-919, June.
  4. Waszczuk, Antonina, 2013. "A risk-based explanation of return patterns—Evidence from the Polish stock market," Emerging Markets Review, Elsevier, vol. 15(C), pages 186-210.
  5. Walker, Eduardo, 2008. "Strategic currency hedging and global portfolio investments upside down," Journal of Business Research, Elsevier, vol. 61(6), pages 657-668, June.
  6. Martin Wielemaker & Eric Gedajlovic, 2011. "Governance and capabilities: Asia’s entrepreneurial performance and stock of venture forms," Asia Pacific Journal of Management, Springer, vol. 28(1), pages 157-185, March.
  7. Korajczyk, Robert A., 1995. "A measure of stock market integration for developed and emerging markets," Policy Research Working Paper Series 1482, The World Bank.
  8. Iqbal, Javed & Brooks, Robert, 2007. "Alternative beta risk estimators and asset pricing tests in emerging markets: The case of Pakistan," Journal of Multinational Financial Management, Elsevier, vol. 17(1), pages 75-93, February.
  9. Lischewski, Judith & Voronkova, Svitlana, 2012. "Size, value and liquidity. Do They Really Matter on an Emerging Stock Market?," Emerging Markets Review, Elsevier, vol. 13(1), pages 8-25.
  10. Matthew D. Merritt & Shaun K. Roache, 2006. "Currency Risk Premia in Global Stock Markets," IMF Working Papers 06/194, International Monetary Fund.
  11. van der Hart, Jaap & Slagter, Erica & van Dijk, Dick, 2003. "Stock selection strategies in emerging markets," Journal of Empirical Finance, Elsevier, vol. 10(1-2), pages 105-132, February.
  12. Demirguc-Kunt, Asli & Levine, Ross, 1995. "Stock market development and financial intermediaries : stylized facts," Policy Research Working Paper Series 1462, The World Bank.
  13. Paul Jansen & Willem Verschoor, 2004. "A note on transition stock return behaviour," Applied Economics Letters, Taylor & Francis Journals, vol. 11(1), pages 11-13.

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