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Return Explanatory Ability and Predictability of Non-Linear Market Models


  • Chi-Hsiou Hung

    () (Durham Business School)


Recent literature supports the pricing of higher-order systematic co-moments of returns. This paper provides some support for the quadratic-market model that is consistent with the three-moment CAPM in explaining time-series returns of the winner and the smallest size portfolios. This study further uses three innovative methodologies in analysing the ability of the linear CAPM, the quadratic- and the cubic-market models in predicting one-period- ahead returns on individual stocks, equally- and value-weighted portfolios of momentum, size and country sorts. The results are surprising but important that the higher-moment CAPM market models do not outperform the linear CAPM in the return predictability tests.

Suggested Citation

  • Chi-Hsiou Hung, 2007. "Return Explanatory Ability and Predictability of Non-Linear Market Models," Working Papers 2007_05, Durham University Business School.
  • Handle: RePEc:dur:durham:2007_05

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    References listed on IDEAS

    1. Brown, Stephen J. & Warner, Jerold B., 1985. "Using daily stock returns : The case of event studies," Journal of Financial Economics, Elsevier, vol. 14(1), pages 3-31, March.
    2. Daniel Chi-Hsiou Hung & Mark Shackleton & Xinzhong Xu, 2004. "CAPM, Higher Co-moment and Factor Models of UK Stock Returns," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 31(1-2), pages 87-112.
    3. Robert A. Korajczyk & Ronnie Sadka, 2004. "Are Momentum Profits Robust to Trading Costs?," Journal of Finance, American Finance Association, vol. 59(3), pages 1039-1082, June.
    4. Rubinstein, Mark E., 1973. "The Fundamental Theorem of Parameter-Preference Security Valuation," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 8(01), pages 61-69, January.
    5. Lim, Kian-Guan, 1989. "A New Test of the Three-Moment Capital Asset Pricing Model," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(02), pages 205-216, June.
    6. Smith, Daniel R., 2007. "Conditional coskewness and asset pricing," Journal of Empirical Finance, Elsevier, vol. 14(1), pages 91-119, January.
    7. Kim, Dongcheol, 1997. "A Reexamination of Firm Size, Book-to-Market, and Earnings Price in the Cross-Section of Expected Stock Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 32(04), pages 463-489, December.
    8. Karen K. Lewis, 2006. "Is the International Diversification Potential Diminishing? Foreign Equity Inside and Outside the US," NBER Working Papers 12697, National Bureau of Economic Research, Inc.
    9. Robert F. Dittmar, 2002. "Nonlinear Pricing Kernels, Kurtosis Preference, and Evidence from the Cross Section of Equity Returns," Journal of Finance, American Finance Association, vol. 57(1), pages 369-403, February.
    10. Jean, William H., 1971. "The Extension of Portfolio Analysis to Three or More Parameters," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 6(01), pages 505-515, January.
    11. Chi-Hsiou Hung, 2007. "Momentum, Size and Value Factors versus Systematic Co-moments in Stock Returns," Working Papers 2007_02, Durham University Business School.
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    More about this item


    Asset Pricing; Non-Linearity; Return Predictability;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets


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