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 well-informed investment decisions.
Asset pricing theory states that investors should be rewarded for the risks that are associated with the state variables, in addition to market risks, which affect their investment opportunity sets. The state variables, however, are latent variables that vary (a) within developed markets (which consist of segmented and international markets); (b) between developed and emerging markets. In this paper, we provide an evaluation of the development of asset pricing theory and an identification of factors that are pervasive and priced in both developed and emerging markets. This survey of the literature suggests there is a need for distinctive asset pricing models that consider the unique characteristics of both markets.
scite is a Brooklyn-based organization that helps researchers better discover and understand research articles through Smart Citations–citations that display the context of the citation and describe whether the article provides supporting or contrasting evidence. scite is used by students and researchers from around the world and is funded in part by the National Science Foundation and the National Institute on Drug Abuse of the National Institutes of Health.
hi@scite.ai
10624 S. Eastern Ave., Ste. A-614
Henderson, NV 89052, USA
Copyright © 2024 scite LLC. All rights reserved.
Made with 💙 for researchers
Part of the Research Solutions Family.