Asset Pricing in Small Sized Developed Markets

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http://hdl.handle.net/10138/41329
Title: Asset Pricing in Small Sized Developed Markets
Author: Butt, Hilal Anwar
Contributor: Svenska handelshögskolan, institutionen för nationalekonomi, nationalekonomi
Hanken School of Economics, Department of Economics, EconomicsHanken School of Economics, Department of Economics, Economics
Publisher: Svenska handelshögskolan
Date: 2013-10-17
Belongs to series: Economics and Society – 261
ISBN: 978-952-232-208-1 (printed)
978-952-232-209-8 (PDF)
ISSN: 0424-7256 (printed)
2242-699X (PDF)
URI: http://hdl.handle.net/10138/41329
Abstract: Asset pricing as a subject is a quest to rationalize different prices associated with different assets that are on offer in financial markets. It does so, using a set of assumptions to mathematically model investors’ behavior, over a set of alternative choices, each leading to an uncertain future outcome. Under this scenario, investors make a choice of foregoing a part of today’s consumption for tomorrow in a way that marginal utility of loss of consumption today is equal to marginal gain in utility tomorrow. This equivalence theoretically determines asset prices. Therefore, there is only one prediction in asset pricing: asset returns must line up with the marginal rate of substitution (MRS) that they provide to the investors. This thesis is an attempt to map in particular the theoretical MRS with empirically available proxies of liquidity risk for small-sized developed markets. In the first essay a number of asset pricing models are tested for the Finnish market. Generally, the results differ in comparison with other markets. For the small Finnish market the significance and size of many risk factors change once equally or value weighted portfolio returns are used. However, the Carhart (1997) model is by far the best performing model for both equally and value weighted portfolios. Once the Capital Asset Pricing model is conditioned with a January dummy the model becomes significant for value weighted portfolios, whereas conditioned with an illiquidity factor, returns are better explained for equally weighted portfolios. The other essays summarize the effect of illiquidity for the Finnish and Nordic equity markets. The proposition that illiquidity matters for illiquid markets is sufficiently fulfilled. In one article we find that of the total return differential between the most illiquid and liquid assets, up to 92% is explained by the liquidity risk factor. For the U.S market the corresponding percentage is 17. Further, the illiquidity factor explains more than the CAPM model. There is also ample evidence that the single most successful illiquidity factor has explanatory capacity that is comparable to that of the three or four factor models of Fama and French (1993) and Carhart (1997) respectively. Finally, illiquidity appears to be important for all the Nordic equity markets. However, this evidence is not revealed using commonly proposed measures of illiquidity. Only when the proposed measure of illiquidity accounts for non-trading intervals and speed of trading, it is found that liquidity risk is linked with expected returns in the Nordic markets.
Subject: asset pricing
finnish stock market
liquidity risk
return variations
exchange rate
zero measure


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