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Too Small or too Low? New Evidence on the 4-Factor Model

  • Paola Brighi

    ()

    (Department of Management, University of Bologna; RCEA; CEFIN)

  • Stefano d’Addona

    ()

    (Department of International Studies, University of Rome III)

  • Antonio Carlo Francesco Della Bina

    ()

    (Department of Management, University of Bologna ; RCEA)

The aim of this paper is to study the pricing factor structure of Italian equity returns. Using twenty five years of data, we focus on the role of other risk factors besides the market beta, namely size, book to market, and momentum. A two step empirical analysis is provided where first we estimate an unrestricted multi-factor model to test if there is any evidence of misspecification. Then, we estimate the restricted model, i.e. with pricing errors equal to zero, through the Generalized Methods of Moments (GMM). We find that the market premium and the size premium for stocks are confirmed for a domestic Italian investor. On the contrary, according to our asset pricing tests, weak evidence is found for the value premium. Finally, we highlight, coherently with recent evidence on other countries but in contrast with previous evidence for the Italian stock market, that augmenting the model with a momentum factor does not improve its performance.

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Paper provided by The Rimini Centre for Economic Analysis in its series Working Paper Series with number 31_10.

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Date of creation: Jan 2010
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Handle: RePEc:rim:rimwps:31_10
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  1. Mirela Malin & Madhu Veeraraghavan, 2004. "On the Robustness of the Fama and French Multifactor Model: Evidence from France, Germany, and the United Kingdom," International Journal of Business and Economics, College of Business, and College of Finance, Feng Chia University, Taichung, Taiwan, vol. 3(2), pages 155-176, August.
  2. Knez, Peter J & Ready, Mark J, 1997. " On the Robustness of Size and Book-to-Market in Cross-Sectional Regressions," Journal of Finance, American Finance Association, vol. 52(4), pages 1355-82, September.
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  6. K. Rouwenhorst, 1996. "International Momentum Strategies," Yale School of Management Working Papers ysm36, Yale School of Management, revised 01 Feb 2008.
  7. Hall, Alastair R., 2004. "Generalized Method of Moments," OUP Catalogue, Oxford University Press, number 9780198775201, March.
  8. L'Her, Jean-Francois & Masmoudi, Tarek & Suret, Jean-Marc, 2004. "Evidence to support the four-factor pricing model from the Canadian stock market," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 14(4), pages 313-328, October.
  9. Fletcher, Jonathan, 1997. "An examination of the cross-sectional relationship of beta and return: UK evidence," Journal of Economics and Business, Elsevier, vol. 49(3), pages 211-221.
  10. Bhandari, Laxmi Chand, 1988. " Debt/Equity Ratio and Expected Common Stock Returns: Empirical Evidence," Journal of Finance, American Finance Association, vol. 43(2), pages 507-28, June.
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  16. repec:ebl:ecbull:v:7:y:2007:i:7:p:1-10 is not listed on IDEAS
  17. 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.
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  19. Bulkley, George & Nawosah, Vivekanand, 2009. "Can the Cross-Sectional Variation in Expected Stock Returns Explain Momentum?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(04), pages 777-794, August.
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  23. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
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