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Unformatted text preview: Multifactor Asset Pricing Model and Stock Markets in Transition: New Empirical Tests Miroslav Mateev * , Atanas Videv ** Eastern Economic Journal , Volume 33, issue 4, 2008 ABSTRACT This paper studies empirically the role of different economy-wide factors in explaining cross- sectional variation in stock returns in emerging markets. Using a sample of common stocks, traded on the Bulgarian stock exchange, we examine the relationship between macroeconomics and capital markets in order to determine whether the variations in stock returns can be explained by macroeconomic variables that might proxy for relevant systematic factors. We use a two-pass regression procedure following the Chen, Roll and Ross (1986) approach. Relevant macroeconomic variables such as trade deficit, unexpected inflation and country risk premium are found to play a significant role in explaining the fluctuations of stock returns in emerging markets. JEL classification: G10, G12 Keywords: excess return, beta, risk premium, multifactor model, market efficiency, asset pricing * Associate professor of Finance, American University in Bulgaria, 2700 Blagoevgrad, Bulgaria,. Phone: +359 73 888 404, Fax: +359 73 880 828, e-mail: [email protected] ** Managing director, BoraInvest Company., 1000 Sofia, Bulgaria, Phone: +359 2 980 47 70, Fax: +359 2 980 47 70, e-mail: [email protected] . The authors are grateful the two anonymous referees for their useful comments. 1 1. Introduction This paper studies empirically the role of different economy-wide factors or macroeconomic variables in explaining excess stock returns in emerging markets. The empirical linkage between macroeconomic variables and capital markets has been widely investigated in the economic literature. For instance, Fama (1981) finds strong evidence of a negative relationship between inflation and stock returns. In addition, Schwert (1989) finds evidence that stock volatility is related to the level of economic activity and that stock market volatility increases during recessions. Other macroeconomic variables that have been found to influence stock returns are industrial production, dividend yields and interest rates; variables typically used in the estimation of the business cycle. Chen, Roll and Ross (1986) use a set of five relevant macroeconomic indicators to paint a broad picture of the macro-economy. Jagannathan and Wang (1996) include the ‘human capital’ factor in their cross-sectional regression model and assume that the return on human capital is an exact linear function of the growth rate in per capita labour income. Fama and French (1996) present an alternative approach to specifying macroeconomic factors using firm characteristics that seem, on empirical grounds, to represent exposure to systematic risk....
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- stock returns