Cross-Section of Returns in Frontier Markets: Evidence from the GCC Markets

ABSTRACT

Many variables have been used to explain a significant proportion of the cross-section of returns, mainly size and book-to-market. We investigate whether stock returns in the frontier markets of the GCC are driven by the same drivers. Additionally, we test other variables, such as β, leverage, momentum, and the price-to-earnings ratio. We conclude by examining which of the empirical asset pricing models (CAPM or three-factor) best describes returns in the GCC markets.

KEY WORDS:

• asset pricing
• CAPM
• expected stock returns
• frontier markets
• GCC
• size effect
• three-factor model
• value effect

JEL:

• F21
• G12
• G14
• G15

Supplementary material

The supplemental data for this article can be accessed here.

Notes

1. The GCC comprises Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and UAE.

2. Emerging markets indices: Is fundamental change coming? The National. 27 Sep 2017. Retrieved from https://www.thenational.ae/business/markets/emerging-markets-indices-is-fundamental-change-coming-1.662062.

3. Kuwait triumphs in Emerging Market quest, more work for Saudi Arabia. The National. 30 Sep 2017. Retrieved from https://www.thenational.ae/business/markets/kuwait-triumphs-in-emerging-market-quest-more-work-for-saudi-arabia-1.662972.

4. World Bank Data. Market Cap in US$ as of Dec 2016.

5. Table S1 in the online Supplementary Material reports the average number of listed firms and their market capitalization in US$ over time and across our seven sample markets.

6. The number of firms in the financial sector using the definition of the SIC in each market out of the total number of stock is as follows: Abu Dhabi 38 (63), Bahrain 22 (38), Dubai 31 (50), Kuwait 118 (220), Oman 33 (105), Qatar 26 (47), Saudi Arabia 59 (178).

7. Exchange rates between the GCC countries are very stable due to their local currencies either being pegged to the US dollar or a basket with a heavy tilt to the dollar. Additionally, the economies have been characterized by a low inflation regime with inflation and interest rates tending to move broadly in parallel between countries (Sturm and Siegfried 2005). This would result in our results being unaffected if returns were to be calculated in a single currency.

8. Over 94% of our firms have December fiscal year ends.

9. In terms of accounting data availability, 90.0% (82.6%)of our stock-month return observation have an associated B/M (E/P).

10. An additional step we take is to remove microcaps which we define as the bottom 5th percentile in each market (Waszczuk 2014). Our results are not altered by this.

11. Equal-weighting of portfolios is used by many, such as Fama and French (1992) and Fama and French (1996) amongst others. Vaihekoski (2004) points out that the cross-sectional variety of the assets is captured better by equal-weighting.

12. Table S3 in the online Supplementary Material contains additional summary statistics on the size-ranked portfolio.

13. Table S4 in the online Supplementary Material contains additional summary statistics on the size-ranked portfolio.

14. Table S5 in the online Supplementary Material contains additional summary statistics on the size-ranked portfolio.

15. Table S6 in the online Supplementary Material contains additional summary statistics on the size-ranked portfolio.

16. This lack of momentum in our sample markets is consistent even when we use various windows ranging from 3 to 12 months for past returns.

17. Many studies use U.S. Treasury rates as the risk-free rate for international studies (e.g., Cakici, Fabozzi, and Tan 2013; Fama and French 2012; Lischewski and Voronkova 2012). However, we feel that such rates could depart significantly from the level of rates in emerging economies.

18. We have also used Fama and French (2012) size cutoffs which state that firms compromising the top 90% of market capitalization are classified as large with the rest as small. Our results do not observe significant departure from the current results.

19. The Four-factor model was tested and did not generate any improvement in its performance beyond that of the Three-factor model. This would go along with the lack of existence of the Momentum effect as mentioned earlier.

20. http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html.

Additional information

Funding

This work has benefited greatly from the comments and suggestions of Fahad Almudhaf. I would also like to thank seminar participants in Kuwait University. All errors are my own. This work was supported and funded by Kuwait University Research Grant number IF01/18.