Long-run adjustment of size, value, momentum and growth premium in equity returns: Evidence from South Asian emerging markets

ABSTRACT

This study scrutinizes the long-run adjustment of risk premiums in equity returns of the emerging stock markets of Pakistan, China and India, the three emerging South Asian economies, by keeping in view leading contributions of the Fama and French (1992) and Carhart (1997) models. Unlike the multifactor models based on macroeconomic factors, this study integrates firm-specific risk factors related to the market premium. The firm-specific growth factor, derived by Ho, Strange, and Piesse (2008), is incorporated as GML, which is based on assets to market value of the firm. The results from a sample of 1 198 companies, taken from three emerging markets for the period of 2001−2013, indicate that market risk premium is the leading factor affecting risk premium in Pakistan and India. Further results reveal that, although market momentum is high enough to overestimate betas in the short run, it congregates to stabilisation and correction in the long run. In contrast, Chinese markets appear to be predominantly reflective of risk factor explaining risk premium, and are relatively more stable and efficient, clearly representing their maturity. Smaller stocks deliver higher returns with higher volatility that is apparently consistent with the general notion of high risk associated with high returns. Growth stocks outperform value stocks in the economies of Pakistan, China and India. Moreover, these markets head towards illiquidity in pre-financial crises periods, but market recovery is observed in post-financial crises periods.

KEYWORDS:

• Global financial crises
• market gearing; Fama-French
• long-term relationship
• partial adjustment model

JEL CLASSIFICATION:

• G1
• G3

Notes

1. Previous studies based the long-run consistency analysis on the employment of longer time series in the model. However, this is not the case as the long-run adjustment identifies the long-run consistency and adjustments.

2. The adjustment coefficient refers to the rate at which the factor loading adjusts in short runs that cumulatively lead to complete adjustment in the long run.

3. In analysis, the term liquidity and growth is used interchangeably.

4. In order to identify the impact of other environmental factors, the data is dissected into two portions and estimated individually. The results remain the same in both portions.

5. The firm-specific growth coefficient is referred to as growth beta

6. The robustness of the coefficients is tested through the Wald Coefficient restriction test, which identified that coefficients depict true effects of the factor on stock returns. The results are not reported here because of lack of space.