Skip to main content
SpringerLink
Log in

Asset Pricing Test Using Alternative Sets of Portfolios: Evidence from India

  • Published:
Asia-Pacific Financial Markets Aims and scope Submit manuscript

Abstract

Empirical test of asset-pricing models are typically performed on portfolios based on firm-characteristics such as size and book-to-market ratios etc. However, because of their strong factor structure, the characteristic sorted portfolios do not provide a sufficient test for asset pricing models. In recent, the appropriateness to use characteristics sorted portfolios has been debated. Literature suggests various alternative test portfolios sorted by other attributes to improve the empirical tests. To address this issue, we construct three sets of test portfolios sorted by firm beta, volatility, and clustering method to test various asset pricing models. We examine whether portfolios sorted by the above methods can improve the explanatory power of various alternative asset pricing models. Our test results suggest that for unconditional models, the statistical significance and estimated risk premiums depend on the choice of tests portfolios. The conditional model has more power to explain the variation of average returns than the unconditional model.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

  1. BSE Ltd, the first ever stock exchange in Asia & the fastest Stock Exchange in world with the speed of 6 μs established in 1875 and have more than 5500 companies listed on BSE. The companies listed on BSE Ltd. command a total market capitalization of USD 1.64 Trillion as of September 2015. SENSEX is India's most widely tracked stock market benchmark index. Source: http://www.bseindia.com.

References

  • Agarwalla, S. K., Jacob, J., Varma, J. R., & Vasudevan, E. (2014). Betting against beta in the Indian market, W.P. No. 2014-07-01. Ahmedabad: Indian Institute of Management.

    Google Scholar 

  • Ahn, D. H., Conrad, J., & Dittmar, R. F. (2009). Basis assets. Review of Financial Studies, 22(12), 5133–5174.

    Article  Google Scholar 

  • Ang, A., Hodrick, R. J., Xing, Y., & Zhang, X. (2006). The cross-section of volatility and expected returns. Journal of Finance, 59(1), 259–299.

    Article  Google Scholar 

  • Ang, A., Liu, J., & Schwarz, K. (2016). Using stocks or portfolios in tests of factor models. Working paper, NBER.

  • Ansari, V. A., & Khan, S. (2012). Momentum anomaly: Evidence from India. Managerial Finance, 38(2), 206–223.

    Article  Google Scholar 

  • Banz, R. W. (1981). The relationship between return and market value of common stocks. Journal of Financial Economics, 9(1), 3–18.

    Article  Google Scholar 

  • Barras, L. (2018). A large-scale approach for evaluating asset pricing models. Journal of Financial Economics. https://doi.org/10.2139/ssrn.2081913.

  • Basu, S. (1977). Investment performance of common stocks in relation to their price–earnings ratios: A test of the efficient market hypothesis. Journal of Finance, 32(3), 663–682.

    Article  Google Scholar 

  • Bhandari, L. C. (1988). Debt/equity ratio and expected common stock returns: Empirical evidence. Journal of Finance, 43(2), 507–528.

    Article  Google Scholar 

  • Black, F., Jensen, M. C., & Scholes, M. (1972). The capital asset pricing model: Some empirical tests. In M. C. Jensen (Ed.), Studies in the theory of capital markets (pp. 79–124). Praeger: Praeger Publishers Inc.

    Google Scholar 

  • Brown, S. J., & Goetzmann, W. N. (1997). Mutual fund styles. Journal of Financial Economics, 43(3), 373–399.

    Article  Google Scholar 

  • Cakici, N., Fabozzi, F., & Tan, S. (2013). Size, value, and momentum in emerging market stock returns. Emerging Markets Review, 16, 46–65.

    Article  Google Scholar 

  • Carhart, M. M. (1997). On persistence in mutual fund performance. Journal of Finance, 52(1), 57–82.

    Article  Google Scholar 

  • Cochrane, J. H. (2005). Asset pricing. Princeton and Oxford: Princeton University Press.

    Google Scholar 

  • Daniel, K., & Titman, S. (2012). Testing factor-model explanations of market anomalies. Critical Finance Review, 1(1), 103–139.

    Article  Google Scholar 

  • Das, S. (2015). Empirical evidence of conditional asset pricing in Indian stock market. Economic Systems, 39(2), 225–239.

    Article  Google Scholar 

  • Das, S., & Barai, P. (2016). Size, value and momentum in stock returns: Evidence from India. Macroeconomics and Finance in Emerging Market Economies, 9(3), 284–302.

    Article  Google Scholar 

  • Ecker, F. (2013). Asset pricing tests using random portfolios. Duke University, The Fuqua School of Business. https://faculty.fuqua.duke.edu/~fecker/Ecker2013.pdf. Accessed July 2017.

  • Falkenstein, E. (1994). Mutual funds, idiosyncratic variance, and asset returns. PhD Dissertation. Northwestern University.

  • Fama, E. F., & French, K. R. (1989). Business conditions and expected returns on stocks and bonds. Journal of Financial Economics, 25(1), 23–49.

    Article  Google Scholar 

  • Fama, E. F., & French, K. R. (1992). The cross-section of expected stock returns. Journal of Finance, 47(2), 427–465.

    Article  Google Scholar 

  • Fama, E. F., & French, K. R. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33, 3–56.

    Article  Google Scholar 

  • Fama, E. F., & French, K. R. (2015). A five-factor asset pricing model. Journal of Financial Economics, 116, 1–22.

    Article  Google Scholar 

  • Fama, E. F., & MacBeth, J. D. (1973). Risk, return, and equilibrium: Empirical tests. Journal of Political Economy, 81(3), 607–636.

    Article  Google Scholar 

  • Ferson, W. E., & Harvey, C. R. (1999). Conditioning variables and the cross section of stock returns. Journal of Finance, 54(4), 1325–1360.

    Article  Google Scholar 

  • Ferson, W. E., & Schadt, R. (1996). Measuring fund strategy and performance in changing economic conditions. Journal of Finance, 51(2), 425–462.

    Article  Google Scholar 

  • Ghysels, E., & Jacquier, E. (2006). Market beta dynamics and portfolio efficiency. Working paper, University of North Carolina and HEC Montreal. http://ssrn.com/abstract=711942. Accessed March 2013.

  • Kan, R., Robotti, C., & Shanken, J. (2013). Pricing model performance and the two-pass cross sectional regression methodology. Journal of Finance, 68(6), 2617–2649.

    Article  Google Scholar 

  • King, M. R. (2009). The cost of equity for global banks: A CAPM perspective from 1990 to 2009. BIS Quarterly Review, Bank for International Settlements, September, pp 59–73

  • Levy, H. (1978). Equilibrium in an imperfect market: A constraint on the number of securities in the portfolio. The American Economic Review, 68(4), 643–658.

    Google Scholar 

  • Lewellen, J., Nagel, S., & Shanken, J. (2010). A skeptical appraisal of asset pricing tests. Journal of Financial Economics, 96(2), 175–194.

    Article  Google Scholar 

  • Lo, A. W., & MacKinlay, A. C. (1990). Data-snooping biases in tests of financial asset pricing models. Review of Financial Studies, 3(3), 431–467.

    Article  Google Scholar 

  • Malkiel, B. G., & Xu, Y. (2002). Idiosyncratic risk and security returns. University of Texas at Dallas, Unpublished.

  • Murtazashvilia, I., & Vozlyublennaia, N. (2013). When do characteristics-sorted factors mechanically explain returns? Journal of International Financial Markets, Institutions and Money, 25, 119–143.

    Article  Google Scholar 

  • Nanda, S. R., Mahanty, B., & Tiwari, M. K. (2010). Clustering Indian stock market data for portfolio management. Expert Systems with Applications, 37, 8793–8798.

    Article  Google Scholar 

  • Phalippou, L. (2007). Can risk-based theories explain the value premium? Review of Finance, 11(2), 143–166.

    Article  Google Scholar 

  • Polkovnichenko, V., Xu, Y., & Zhao, Y. (2012). Simulation-based analysis of asset pricing model. Working papers, University of Texas, Dallas.

  • Pukthuanthong, L. K., & Visaltanachoti, N. (2009). Idiosyncratic volatility and stock returns: A cross country analysis. Applied Financial Economics, 19(16), 1269–1281.

    Article  Google Scholar 

  • Rahman, S., Schneider, M. J., & Antonacci, G. (2015). Tests of alternative asset pricing models using individual security returns and a new multivariate F-test. https://www.researchgate.net/publication/286379243. Accessed July 2017.

  • Rosenberg, B., Reid, K., & Lanstein, R. (1985). Persuasive evidence of market inefficiency. Journal of Portfolio Management, 11(3), 9–16.

    Article  Google Scholar 

  • Santos, T., & Veronesi, P. (2006). Labor income and predictable stock returns. Review of Financial Studies, 19(1), 1–44.

    Article  Google Scholar 

  • Sehgal, S. (1997). An empirical testing of three parameter capital asset pricing model in India. Finance India, 11(4), 919–940.

    Google Scholar 

  • Shanken, J. (1992). On the estimation of beta-pricing models. Review of Financial Studies, 5(1–2), 1–33.

    Article  Google Scholar 

  • Shanken, J., & Zhou, G. (2007). Estimating and testing beta pricing models: Alternative methods and their performance in simulations. Journal of Financial Economics, 84(1), 40–86.

    Article  Google Scholar 

  • Sumathi, S., & Sivanandam, S. N. (2006). Introduction to data mining and its applications. Berlin: Springer.

    Book  Google Scholar 

Download references

Author information

Authors and Affiliations

  1. Department of Management Studies, Indian Institute of Information Technology, Allahabad, 211015, India

    Sudipta Das

Authors
  1. Sudipta Das
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Sudipta Das.

Additional information

Publisher's Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Das, S. Asset Pricing Test Using Alternative Sets of Portfolios: Evidence from India. Asia-Pac Financ Markets 26, 339–354 (2019). https://doi.org/10.1007/s10690-018-09268-8

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10690-018-09268-8

Keywords

JEL Classification

Search

Navigation