Combining local and global markets in asset pricing in emerging markets: evidence from three BRICS nations
Asset pricing models, originally designed for the US market, assume sufficiency of local market in capturing systematic market risk in the stock returns. The models were extended to other developed markets that are fully integrated with the US market by replacing the local market with the global...
| Main Authors: | , , |
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| Format: | Article |
| Language: | English |
| Published: |
Tennessee State University
2015
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| Subjects: | |
| Online Access: | http://irep.iium.edu.my/44939/ http://irep.iium.edu.my/44939/ http://irep.iium.edu.my/44939/1/Journal_of_Developing_Areas_Vol_49%283%29_365-78_2015-Shabir%2C_Zarinah_and_Kameel.pdf |
| Summary: | Asset pricing models, originally designed for the US market, assume sufficiency of local market in
capturing systematic market risk in the stock returns. The models were extended to other developed
markets that are fully integrated with the US market by replacing the local market with the global
market. However, the ability of these models to capture systematic risks and explain stock returns
in emerging markets is undermined by emerging markets’ partial integration with and structural
differences from the developed markets. In these markets, relying only on local or global market is
expected to cause loss of valuable return-relevant information leading to inaccuracies in the return
estimates. To customize the asset pricing models to emerging markets settings, we propose
combining local and global markets in the models. In this regard, we extend Koedijk et al. model by
replacing global instruments with global market portfolio to propose a two-factor CAPM, and Fama
& French three-factor model by adding global market portfolio as the fourth factor. We test the
proposed models in three BRICS nations, China, India, and South Africa, using ten-year, monthly
data from January 2004 to December 2013 on non-financial firms with positive equity holdings. We
apply Fama & French double sort on size and book to market value of equity on listed firms to
construct nine dependent portfolios. The sort procedure is also used to construct two portfolios—
SMB and HML—used along with market portfolios as explanatory variables in Fama & French
models. The test results of the models reveal differences in the behaviors of the markets studied.
The Chinese market behaves like a fully segmented market wherein local market portfolio subsumes
the effect of the global market in both models. On the other hand, the South African market acts like
a partially integrated market where both local and global market portfolios have significant impact
on the stock returns. The Indian market behaves like a segmented market in two-factor model and
like a partially-integrated market in the four-factor model. Hence, we conclude that incorporation of
local and global markets in asset pricing in emerging markets in necessary to insure against
inaccuracies in the stock return estimates. The proposed models provide investors and investment
managers with tools for gauging risks involved in investing in emerging markets and making wellinformed
investment decisions. |
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