Abstract
The main purpose of this paper is to explore the cross-sectional relationship between security returns and beta, size and book-to-market equity in the Shanghai A-share market. This study takes place during the period January 1997–December 2006. The methodology of Fama and French (J Finance 51:55–84, 1992) and Pettengill et al. (J Financial Quant Anal 30:101–116, 1995) is adopted. The Results show no evidence of an unconditional relationship between beta and returns. However, a conditional relationship is found when the data is split into up and down markets. The relationship holds even in the presence of size and book-to-market equity. Both size and book-to-market equity is found to be priced by the market and thereby regarded as significant determinants of security returns.
Similar content being viewed by others
Notes
Studies outside of the US and European markets include; Ho et al. (2000) and Lam (2001) in the Hong Kong market, Faff (2001) in the Australian market, and Sandoval and Saens (2004) examining the markets of Argentina, Brazil, Chile and Mexico. All these studies fail to find an unconditional relationship between beta and returns.
The methodology of Pettengill et al. (1995) can be adopted to test the significance of beta as a risk measurement. It is not a test of the CAPM, for the CAPM does not state what the ex-post relationship between risk and return should be.
Further studies by Isakov (1999), Faff (2001), Lam (2001), Elsas et al. (2003) and Sandoval and Saens (2004), studying the Swiss, Australian, Hong Kong, German and Latin American markets respectively, all provide evidence in support of beta as a significant risk measurement when applying the Pettengill et al. (1995) methodology.
The Chinese government, by allow investors outside of China to invest in the A-share market, has commenced the process of integration with other major global markets. During 2005 the Chinese government began a programme to increase the number of A-shares available for trading thereby starting a process to reduce government ownership. Restrictions do still exist, such as foreign investment restrictions, that impede the integration process.
Prior to the opening of the B-share market to domestic Chinese investors there existed significant price differential between A and B-shares. A study by Yeh et al. (2002) found that the price premium with respect to A-shares had a significant influence on the return on both A and B-shares. Price differentials still exist, though to a lesser extent, due to the fact that foreign investors of B-shares require a greater return than Chinese investors in A-shares given that foreign investors expect to be compensated for the political risk associated with investing in China. An empirical study by Zhang and Zhao (2003) found that international investors respond differently to the political risk that exists within China. Clearly other factors in addition to political risk, such as differences in liquidity, information availability, economic risk, all contribute to the price differential.
The time period of this study incorporates the Asian financial crisis of 1997–1998, often referred to as the IMF (International Monetary Fund) crisis. The financial crisis represented a period of economic turmoil that effected currencies and stock markets. The main Asian countries effected were; Hong Kong, Indonesia, Malaysia, Philippines, South Korea and Thailand. Mainland China was virtually unaffected thus the Asian crisis does not have any real impact for this study.
The sample period commences in January 1997, for given that all tests are conducted using portfolios it is necessary to have enough securities in the A-share market in order to construct sufficient portfolios to run the cross–sectional regressions. Prior to this period the number of securities in various years was to low.
This approach was first adopted by Fama and MacBeth (1973).
The rational behind Pettengill et al. (1995) approach is the recognition that the risk-return relationship of the CAPM is one based on expected returns and not realised returns. The expectation is that the excess market return will always be positive, as discussed in Sect. 1, however the realised excess market return will at times be negative. The Pettengill et al. (1995) methodology recognises this and thus segments the data depending upon whether the excess market return is positive or negative, and then tests the beta-return relationship conditionally upon the sign of the excess market return.
By assigning portfolio betas to individual securities permits tests to be performed using individual securities rather then portfolios. This provides two advantages, firstly it improves the statistical power of the test due to the larger data available, and secondly it prevents the dilution of size and book-to-market equity variables given that these are available for each security.
Size-beta portfolios allow for variations in beta that are not related to size.
The βi in all subsequent equations signifies the portfolio beta assigned to each security within its corresponding portfolio.
As discussed in Sect. 1, the A-share market consists of tradable and non tradable shares. The average monthly return (based on a value weighted portfolio) and the beta of the non-tradable shares in the sample is 0.86% and 0.81 respectively.
The study by Wang and Di Iorio (2007) define up markets as all months with a positive market return and down markets all months with a negative market return. They do not use market excess returns. It is therefore possible that various months may well have had a negative market risk premium though were included in up market data (a positive market return though less than the risk free rate). The difference in defining an up and down market may well explain the differing conclusions with respect to beta drawn from this paper to that of Wang and Di Iorio (2007).
An analysis of the monthly seasonality in the relationship between returns and beta, size, and book-to-market equity is also examined (Results not reported though available upon request). It is found that the results shown in Tables 2 and 3 are not due to any abnormal seasonal observations, thus supporting the argument that any premium payments found represent risk payments.
Fletcher (1997) on examining the UK market also produces similar findings regarding the symmetry hypothesis, which he describes as puzzling.
References
Banz RW (1981) The relationship between returns and market value of common stocks. J Financ Econ 9:3–18
Black F (1972) Capital market equilibrium with restricted borrowing. J Bus 45:444–455
Black F, Jensen MC, Scholes M (1972) The capital asset pricing model: some empirical tests. In: Jensen MC (ed) Studies in the theory of capital markets. Praeger, NY, pp 79–124
Chan KC, Chen N (1991) Structural and return characteristics of small and large firms. J Finance 46:1467–1484
Chan A, Chui APL (1996) An empirical re-examination of the cross-section of expected returns: UK Evidence. J Bus Finance Account 23:1435–1452
Chan LK, Hamao Y, Lakonishok J (1991) Fundamental and stock returns in Japan. J Finance 46:1739–1789
Cheng S (2009) An analysis of China’s stock market in the first 10 years. Rev Pac Basin Financ Mark Policies 12:629–653
Chui CW, Wei KC (1998) Book-to-market, firm size, and the turn of the year effect: Evidence from the Pacific-Basin emerging markets. Pac Basin Finance J 6:275–293
Davis J (1994) The cross-section of realised stock returns: the pre-compustat evidence. J Finance 49:1579–1593
Elsas R, El-Shaer M, Theissen E (2003) Beta and returns revisited: evidence from the German stock market. J Int Financ Markets Inst Money 13:1–18
Eun CS, Huang W (2007) Asset pricing in China’s domestic stock market: is there logic. Pac Basin Finance J 15:452–480
Faff R (2001) A multivariate test of a dual beta CAPM: Australian evidence. Financ J Rev 36:157–174
Fama E, French K (1992) The cross-section of expected stock returns. J Finance 47:427–467
Fama E, French K (1995) Size and book-to-market factors in earnings and returns. J Finance 50:131–155
Fama E, French K (1996) Multifactor explanations of asset pricing anomalies. J Finance 51:55–84
Fama E, MacBeth J (1973) Risk return and equilibrium: empirical tests. J Polit Econ 81(May–June):607–636
Fletcher J (1997) An examination of the cross-sectional relationship of beta and return: UK evidence. J Econ Bus 49:211–221
Grinold R (1993) Is beta dead? Financ Anal J 49:28–34
Hadoshima J, Garaz-Gomez X, Kunimura M (2000) Cross-sectional regression analysis of return and beta in Japan. J Econ Bus 52(6):513–533
Ho RYW, Strange R, Piesse J (2000) CAPM anomalies and the pricing of equity: evidence from the Hong Kong market. Appl Econ 32:1629–1636
Ho RYW, Strange R, Piesse J (2006) On the conditional pricing effects of beta, size, and book-to-market equity in the Hong Kong market. J Int Financ Markets Inst Money 16(3):199–214
Hung DCH, Shackleton M, Xu X (2004) CAPM, higher co-moments and factor models of UK stock returns. J Bus Finance Account 31(1, 2):87–112
Isakov D (1999) Is beta still alive? Conclusive evidence from the Swiss stock market. Eur J Finance 5:202–212
Lam SK (2001) The conditional relation between beta and returns in the Hong Kong stock market. Appl Financ Econ 11:669–680
Lau ST, Lee CT, McInish TH (2002) Stock returns and beta, firm size, E/P, CF/P, book-to-market equity, and sales growth: evidence from Singapore and Malaysia. J Multinational Financ Manage 12:207–222
Levis M (1985) Are small firms big performers. Investment Anal 76:21–26
Levis M, Liodakis M (2001) Contrarian strategies and investor expectations: the UK evidence. Financ Anal J 57(5):43–56
Lilti JJ, Montagner RL (1998) Beta, size and return: a study on the French stock exchange. Appl Financ Econ 8:13–20
Lintner J (1965) The valuation of risky assets and the selection of risky investments in stock portfolios and capital budgets. Rev Econ Stat 47:13–37
Lu C, Wang K, Chen H, Chong J (2007) Integrating A- and B-share markets in China: the effects of regulatory policy changes on market efficiency. Rev Pac Basin Financ Markets Policies 10:309–328
Morelli D (2007) Beta, size, book-to-market equity and returns: a study based on UK data. J Multinational Financ Manage 17:257–272
Ning GR, Lui P (2004) Empirical tests of the CAPM in the shanghai stock market. J Shijiazhuang Univ Econ 27:194–197
Pettengill G, Sundaram S, Mathur I (1995) The conditional relation between beta and returns. J Financ Quant Anal 30:101–116
Pettengill G, Sundaram S, Mathur I (2002) Payment for risk: constant beta vs dual beta models. Financ Rev 37:123–136
Poon S, Taylor SJ (1991) Macroeconomic factors and the UK stock market. J Bus Finance Account 18:619–636
Rosenberg B, Reid K, Lanstein R (1985) Persuasive evidence of market inefficiency. J Portf Manage 11:9–17
Sandoval E, Saens R (2004) The conditional relationship between portfolio beta and return: evidence from Latin America. Cuadernos de Economia 41:65–89
Sharpe W (1964) Capital asset prices: a theory of market equilibrium under conditions of risk. J Finance 19:425–442
Stattman D (1980) Book values and stock returns. Chic MBA J Selected Papers 4:25–45
Strong N, Xu XG (1997) Explaining the cross-section of UK expected stock returns. Br Account Rev 29:1–23
Wang Y, Di Iorio A (2007a) The cross-sectional relationship between stock returns and domestic and global factors in the Chinese A-share market. Rev Quant Financ Acc 29:181–203
Wang Y, Di Iorio A (2007b) The cross section of expected stock returns in the Chinese A-share market. Global Finance J 17:335–349
Wong KA, Tan RSK, Liu W (2006) The cross-section of stock returns on the shanghai stock exchange. Rev Quant Financ Acc 26:23–39
Yeh YH, Lee TS, Pen JF (2002) Stock returns and volatility under market segmentation: the case of Chinese A and B shares. Rev Quant Financ Acc 18:239–257
Zhang T, Zhao R (2003) Risk under one country and two systems: evidence from class A, B, and H shares of Chinese listed companies. Rev Pac Basin Finan Markets Policies 6:179–197
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Morelli, D. Security returns, beta, size, and book-to-market equity: evidence from the Shanghai A-share market. Rev Quant Finan Acc 38, 47–60 (2012). https://doi.org/10.1007/s11156-010-0218-8
Published:
Issue Date:
DOI: https://doi.org/10.1007/s11156-010-0218-8