Article2017

Explaining Anomalies in Australia with a Five‐factor Asset Pricing Model

44 citations0/0 files storedInternational Review of Finance

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Financial Markets and Investment Strategies Financial Analysis and Corporate Governance Financial Risk and Volatility Modeling

Abstract

Abstract This paper compares the ability of three‐factor and five‐factor asset pricing models to explain the apparent profitability of a broad selection of anomalies in Australian equity returns. Rather than examining the fit of each model to common test portfolios, our focus is on the spread return to long–short trading strategies designed around so‐called anomalies. After documenting significant spread returns to 16 anomalies (including several not previously studied in Australia), the empirical analysis provides cautious support that the recently‐proposed investment and profitability factors have a role to play. The number of anomalies that remains after risk adjustment decreases under the five‐factor model. Further, while the magnitude of reduction in alpha is modest, our testing shows that it is statistically significant in many cases. However, both three‐factor and five‐factor models repeatedly fail the Gibbons, Ross, and Shanken's (1989) (GRS) test, suggesting that the quest for a better asset pricing model is not yet complete.

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1993Common risk factors in the returns on stocks and bonds 1964CAPITAL ASSET PRICES: A THEORY OF MARKET EQUILIBRIUM UNDER CONDITIONS OF RISK*1997On Persistence in Mutual Fund Performance 1968FINANCIAL RATIOS, DISCRIMINANT ANALYSIS AND THE PREDICTION OF CORPORATE BANKRUPTCY 1964The Structure of Scientific Revolutions.2014A five-factor asset pricing model 1965The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets 1975THE VALUATION OF RISK ASSETS AND THE SELECTION OF RISKY INVESTMENTS IN STOCK PORTFOLIOS AND CAPITAL BUDGETS**This paper is another in a series of interrelated theoretical and statistical studies of corporate financial and investment policies being made under grants from the Rockefeller Foundation, and more recently the Ford Foundation, to the Harvard Business School. The generous support for this work is most gratefully acknowledged. The author is also much indebted to his colleagues Professors Bishop, Christenson, Kahr, Raiffa, and (especially) Schlaifer, for extensive discussion and commentary on an earlier draft of this paper; but responsibility for any errors or imperfections remains strictly his own.[Professor Sharpe's paper, “Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk” (Journal of Finance, September 1964) appeared after this paper was in final form and on its way to the printers. My first section, which parallels the first half of his paper (with corresponding conclusions), sets the algebraic framework for sections II, III and VI, (which have no counterpart in his paper) and for section IV on the equilibrium prices of risk assets, concerning which our results differ significantly for reasons which will be explored elsewhere. Sharpe does not take up the capital budgeting problem developed in section V below.]

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