Term Structure of Risk Factor Premiums Used for Pricing Asset: Emerging vs. Developed Markets

ABSTRACT

The aim of this empirical study was to estimate and compare the term structure of risk factor premiums in developed and emerging markets. Most studies use dividend and variance swap data, but as that information is not available for all markets, we use wavelet decomposition of the observed return to calculate sensitivity to risk factors and obtain a term structure for risk factor premiums. The results show that only the market risk factor (for both types of markets) and the conservative minus aggressive factor (only for developed markets) show a term structure for risk premiums.

KEYWORDS:

• Term structure
• risk premium
• wavelets
• multi-factorial CAPM
• time-frequency decomposition

JEL CLASSIFICATION:

• C32
• C38
• G12

Acknowledgments

I am grateful to Professor Paresh Kumar Narayan (editor) and two anonymous referees for their insightful comments.

Declaration Of Interest Statement

The author declares no conflict of interest.

Supplemental Material

Supplemental data for this article can be accessed on the publisher’s website.

Notes

1. According to Percival and Walden (2006) and to avoid the assumption of circularity, this requires the condition J < log₂[N/(L-1)], where L is the width of the wavelet filter.

2. Note that we use continuous wavelet transform instead of discrete decomposition. We could determine neither the betas for different time scales nor the risk premiums from the scale betas.

3. Available at: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html#International.

4. Daubechies Least Asymmetric filter with a wavelet filter length of eight observations is a common wavelet filter in other empirical studies of financial markets (see Gençay, Selc¸uk, and Whitcher 2005; Fernandez 2006; Rhaeim, Ammou, and Mabrouk 2007).

5. The rest of the results are available upon request.

Additional information

Funding

This work has been supported by the Spanish Ministry of Economics and Competitiveness under grant MINECO/FEDER ECO2015-65826-P.

Notes on contributors

Mariano González-Sánchez

Dr. Mariano González-Sánchez is an assistant professor at the Universidad Nacional de Educación a Distancia (UNED), Spain’s Public Online University. He is a member of a variety of scientific societies such as the Spanish Club of Risk Management. The research awards he has won include: Best Paper in 11th World Congress of Accounting Educators and Researchers (2011, Singapore). His research focuses on financial risk and asset pricing.