Title: CAPM tests and alternative factor portfolio composition: getting the alphas right
Authors: De Moor, Lieven
Sercu, Piet #
Issue Date: 2005
Publisher: State University - Higher School of Economics
Host Document: Proceedings of the 32nd Annual Meeting of the European Finance Association (EFA)
Conference: Annual Meeting of the European Finance Association (EFA) edition:32 location:Moscow (Russia) date:24-27 August 2005
Abstract: The results of a CAPM test are sensitive to aspects related to the weight one gives to small, low-visibility stocks when constructing the portfolios whose returns serve as left- and right-hand-side variables. It turns out to be the result of a marketwide factor rather than a stock characteristic. To fit the observed returns it suffices to redesign the size and book-to-market factor portfolios into two factor portfolios each, one for the smallest or highest book-to-market stocks relative to other stocks, and one for moderately small or high book-to-market stocks versus larger or growth companies. This alternative 6-factor model does a better job in pricing stocks, both in the US and internationally, than Carhart's 4-factor CAPM with factor portfolios designed following Fama and French (1992, 1993, 1995, 1996a, 1996b, 1998, 2000), Carhart (1997), Jegadeesh and Titman (1993) and Rouwenhorst (1999). The fact that we can resolve mispricing by adding factors rather than characteristics, rules out data problems as an explanation, and information asymmetries. Thin trading bias in the beta is also rejected as the source of extra returns. Liquidity remains a serious possible candidate, as is the hypothesis of extra downside risk for small firms.
Publication status: published
KU Leuven publication type: IMa
Appears in Collections:Research Center International Finance, Leuven
Research Centre for Finance, Accountancy & Tax, Campus Brussels (-)
Faculty of Economics and Business (FEB) - miscellaneous
# (joint) last author

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