Does one model fit all in global equity markets? Some insight into market factor based strategies in enhancing alpha

The sources of risk in a marketplace are systematic, cross‐sectional, and time varying in nature. Though the capital asset pricing model (CAPM) provides an excellent risk–return framework and the market beta may reflect the risk associated with risky assets, there are opportunities for investors to take advantage of dimensional and time‐varying return anomalies in order to improve their investment returns. In this paper, we restrict our analysis to return variations linked to market factor anomalies or factor or dimensional beta using the Fama–French three‐factor; Carhart four‐factor; Fama‐French five‐factor; and Asness, Frazzini, and Pederson (AFP)'s five‐ and six‐factor models. We find significant variations in explaining sources of risk across 22 developed and 21 emerging markets with data over a long period from 1991 to 2016. Each market is unique in terms of factor risk characteristics, and market risk as explained by the CAPM is not the true risk measure. Hence, contrary to the risk–return efficiency framework, we find that lower market risk results in higher excess return in 19 out of the 22 developed markets, which is a major anomaly. However, although in majority of the markets, the AFP models result in reducing market risk (15 countries) and enhancing alpha (11 countries), it is also very interesting to note that the CAPM is second only in generating excess returns in the developed markets. We are conscious of the fact, however, that each market is unique in its composition and trend even over a long time horizon, and hence, a generalized approach in asset allocation cannot be adopted across all the markets.