Cross-sectional Predictability of Indian Stock Returns: A Factor Analytical Approach

Sanjay Shanbhag; Kamran Quddus

doi:10.12775/CJFA.2025.009

Автор(и)

Sanjay Shanbhag Indian Institute of Management, Ranchi https://orcid.org/0009-0009-2809-1999
Kamran Quddus Indian Institute of Management, Ranchi https://orcid.org/0000-0003-3365-381X

DOI:

https://doi.org/10.12775/CJFA.2025.009

Ключові слова

asset pricing, returns predictability, Fama-MacBeth regression, arbitrage pricing, principal components

Анотація

This article's core objective is to analyze how firm characteristics collectively effect the risk-adjusted returns of Indian stocks. It aims to understand the simultaneous explanatory power of multiple variables that have shown to predict the cross-sectional returns in prior studies. We include eight firm characteristics as determinants of expected returns - size, book-to-market equity, reciprocal of share price, volume traded, dividend yield and 3 lagged returns. The data consists of monthly returns and firm characteristics for a sample of listed securities which constitute the National Stock Exchange’s (NSE) NIFTY 100 Index. We use Arbitrage Pricing Theory with Connor and Korajczyk (1988) benchmark factors for risk adjusting returns on individual securities. We conduct Fama-MacBeth regressions to determine the statistical significance of the firm characteristics. We find that lags of size, book to market, dividend yield, and momentum have strong residual pricing power and in-sample predictability of risk adjusted returns. We also find that the intercepts are positive and highly significant. Thus, the average stock in the sample underperforms the risk model by a substantial amount. The results lead us to categorically reject Arbitrage Pricing Model with Connor and Korajczyk factors as a risk model for Indian stock returns.

Посилання

Amihud, Y., & Mendelson, H. (1986). Asset pricing and the bid-ask spread. Journal of Financial Economics, 17(2), 223–249. https://doi.org/10.1016/0304-405x(86)90065-6.

Ansari, V.A., & Khan, S. (2012). Momentum anomaly: Evidence from India. Managerial Finance, 38(2), 206–223. https://doi.org/10.1108/03074351211193730.

Balakrishnan, A. (2016). Size, value, and momentum effects in stock returns: Evidence from India. Vision: The Journal of Business Perspective, 20(1), 1–8. https://doi.org/10.1177/0972262916628929.

Balakrishnan, A., Maiti, M., & Panda, P. (2018). Test of five-factor asset pricing model in India. Vision: The Journal of Business Perspective, 22(2), 153–162. https://doi.org/10.1177/0972262918766133.

Banz, R.W. (1981). The relationship between return and market value of common stocks. Journal of Financial Economics, 9(1), 3–18. https://doi.org/10.1016/0304-405x(81)90018-0.

Barillas, F., & Shanken, J. (2018). Comparing asset pricing models. The Journal of Finance,73(2), 715–754. https://doi.org/10.1111/jofi.12607.

Basu, D., & Chawla, D. (2010). An empirical test of CAPM—The case of Indian stock market. Global Business Review, 11(2), 209–220. https://doi.org/10.1177/097215091001100206.

Basu, D., & Chawla, D. (2012). An empirical test of the arbitrage pricing theory—Thecase of Indian stock market. Global Business Review, 13(3), 421–432. https://doi.org/10.1177/097215091201300305.

Basu, S. (1983). The relationship between earnings’ yield, market value and return for NYSE common stocks. Journal of Financial Economics, 12(1), 129–156. https://doi.org/10.1016/0304-405x(83)90031-4.

Bawa, V.S., & Lindenberg, E.B. (1977). Capital market equilibrium in a mean-lower partialmoment framework. Journal of Financial Economics, 5(2), 189–200. https://doi.org/10.1016/0304-405x(77)90017-4.

Berk, J. B. (2000). Sorting out sorts. The Journal of Finance, 55(1), 407–427. https://doi.org/10.1111/0022-1082.00210.

Black, F., Jensen, M., & Scholes, M. (1972). The capital asset pricing model: some empirical tests. In M. Jensen. Studies in the Theory of Capital Markets. New York: Praeger Publishers.

Carhart, M.M. (1997). On persistence in mutual fund performance. The Journal of Finance, 52(1), 57–82. https://doi.org/10.1111/j.1540-6261.1997.tb03808.x.

Chan, L.K., Jegadeesh, N., & Lakonishok, J. (1995). Momentum strategies. The Journal of Finance, 51, 1681–1713. https://doi.org/10.3386/w5375.

Chen, L., & Zhang, L. (2009). A Better Three-Factor Model that Explains More Anomalies. Journal of Finance, 65(2), 563–594.

Chen, N., Roll, R., & Ross, S.A. (1986). Economic forces and the stock market. The Journal of Business, 59(3), 383–403. https://doi.org/10.1086/296344.

Chordia, T., Goyal, A., & Saretto, A. (2020). Anomalies and False Rejections. The Review of Financial Studies, 33(5), 2134–2179. https://doi.org/10.1093/rfs/hhaa018.

Cochrane, J.H. (2011). Presidential Address: Discount Rates. The Journal of Finance, 66(4), 1047–1108. https://doi.org/10.1111/j.1540-6261.2011.01671.x.

Connor, G. (1995). The three types of factor models: A comparison of their explanatory power. Financial Analysts Journal, 51(3), 42–46. https://doi.org/10.2469/faj.v51.n3.1904.

Connor, G., & Korajczyk, R.A. (1988). Risk and return in an equilibrium APT. Journal of FinancialEconomics, 21(2), 255–289. https://doi.org/10.1016/0304-405x(88)90062-1.

Connor, G., & Korajczyk, R.A. (1993). A test for the number of factors in an approximate factor model. The Journal of Finance, 48(4), 1263–1291. https://doi.org/10.2307/2329038.

Daniel, K., Hirshleifer, D., & Subrahmanyam, A. (1998). Investor psychology and security market under‐ and overreactions. The Journal of Finance, 53(6), 1839–1885. https://doi.org/10.1111/0022-1082.00077.

Das, S. (2015). Empirical evidence of conditional asset pricing in the Indian stockmarket. Economic Systems, 39(2), 225–239. https://doi.org/10.1016/j.ecosys.2014.07.003.

Das, S., & Barai, P. (2015). Time-varying industry beta in Indian stock market and forecasting errors. International Journal of Emerging Markets, 10(3), 521–534. https://doi.org/10.1108/ijoem-02-2013-0035.

Das, S., & Barai, P. (2016). Size, value and momentum in stock returns: Evidence from India. Macroeconomics and Finance in Emerging Market Economies, 9(3), 284–302. https://doi.org/10.1080/17520843.2016.1148754.

Dutta, A. (2019). Does the five-factor asset pricing model have sufficient power? Global Business Review, 20(3), 684–691. https://doi.org/10.1177/0972150919837060.

Fama, E.F. (1991). Efficient capital markets: II. The Journal of Finance, 46(5), 1575–1617. https://doi.org/10.2307/2328565.

Fama, E.F., & French, K.R. (1988). Dividend yields and expected stock returns. Journal of Financial Economics, 22(1), 3–25. https://doi.org/10.1016/0304-405x(88)90020-7.

Fama, E.F., & French, K.R. (1992). The cross-section of expected stock returns. The Journal of Finance, 47(2), 427–465. https://doi.org/10.2307/2329112.

Fama, E.F., & French, K.R. (2015). A five-factor asset pricing model. Journal of Financial Economics, 116(1), 1–22. https://doi.org/10.1016/j.jfineco.2014.10.010.

Ferson, W.E., Sarkissian, S., & Simin, T. (1999). The Alpha factor asset pricing model: A parable. Journal of Financial Markets, 2(1), 49–68. https://doi.org/10.1016/s1386-4181(98)00005-6.

Gibbons, M.R., Ross, S.A., & Shanken, J. (1989). A test of the efficiency of a given portfolio. Econometrica, 57(5), 1121–1152. https://doi.org/10.2307/1913625.

Goyal, A., & Welch, I. (2003). Predicting the Equity Premium with Dividend Ratios. Management Science, 49(5), 639–654. https://doi.org/10.1287/mnsc.49.5.639.15149.

Harshita, Singh, S., & Yadav, S.S. (2018). Changing nature of the value premium in the Indian stock market. Vision: The Journal of Business Perspective, 22(2), 135–143. https://doi.org/10.1177/0972262918766135.

Harvey, C.R., & Siddique, A. (2000). Conditional skewness in asset pricing tests. The Journal of Finance, 55(3), 1263–1295. https://doi.org/10.1111/0022-1082.00247.

Harvey, C.R., Liu, Y., & Zhu, H. (2015). … and the cross-section of expected returns. Review of Financial Studies, 29(1), 5–68. https://doi.org/10.1093/rfs/hhv059.

Hong, H., & Stein, J.C. (1999). A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets. The Journal of Finance, 54(6), 2143–2184. https://doi.org/10.1111/0022-1082.00184.

Hou, K., Xue, C., & Zhang, L. (2014). Digesting anomalies: An investment approach. Review of Financial Studies, 28(3), 650–705. https://doi.org/10.1093/rfs/hhu068.

Hou, K., Xue, C., & Zhang, L. (2018). Replicating anomalies. The Review of Financial Studies, 33(5), 2019–2133. https://doi.org/10.1093/rfs/hhy131.

Hwang, S., & Satchell, S.E. (1999). Modelling emerging market risk premia using higher moments. International Journal of Finance & Economics, 4(4), 271–296. https://doi.org/10.1002/(SICI)1099-1158(199910)4:4%3C271::AID-IJFE110%3E3.0.CO;2-M.

Hwang, S., & Satchell, S.E. (2012). Testing linear factor models on individual stocks usingthe averagef-test. The European Journal of Finance, 20(5), 463–498. https://doi.org/10.1080/1351847x.2012.717097.

Jegadeesh, N., & Titman, S. (1993). Returns to buying winners and selling losers: Implications for stock market efficiency. The Journal of Finance, 48(1), 65–91. https://doi.org/10.1111/j.1540-6261.1993.tb04702.x.

Jegadeesh, N., & Titman, S. (2001). Profitability of momentum strategies: An evaluationof alternative explanations. The Journal of Finance, 56(2), 699–720. https://doi.org/10.1111/0022-1082.00342.

Keswani, S., Puri, V., & Jha, R. (2024). Relationship among macroeconomic factors andstock prices: Cointegration approach from the Indian stock market. Cogent Economics & Finance, 12(1), 1–20. https://doi.org/10.1080/23322039.2024.2355017.

Khudoykulov, K. (2020). Asset-pricing models: A case of Indian capital market. Cogent Economics & Finance, 8(1), 1–15. https://doi.org/10.1080/23322039.2020.1832732.

Kothari, S.P., Shanken, J., & Sloan, R.G. (1995). Another look at the cross-sectionof expected stock returns. The Journal of Finance, 50(1), 185–224. https://doi.org/10.2307/2329243.

Kraus, A., & Litzenberger, R.H. (1976). Skewness preference and the valuation of riskassets. The Journal of Finance, 31(4), 1085–1100. https://doi.org/10.2307/2326275.

Lakonishok, J., Shleifer, A., & Vishny, R.W. (1994). Contrarian investment, extrapolation, and risk. The Journal of Finance, 49(5), 1541–1578. https://doi.org/10.2307/2329262.

Lehmann, B.N., & Modest, D.M. (1988). The empirical foundations of the arbitragepricing theory. Journal of Financial Economics, 21(2), 213–254. https://doi.org/10.1016/0304-405x(88)90061-x.

Lewellen, J. (2004). Predicting returns with financial ratios. Journal of Financial Economics,74(2), 209–235. https://doi.org/10.1016/j.jfineco.2002.11.002.

Lewellen, J., Nagel, S., & Shanken, J. (2010). A skeptical appraisal of asset pricing tests. Journal of Financial Economics, 96(2), 175–194. https://doi.org/10.1016/j.jfineco.2009.09.001.

Liew, J., & Vassalou, M. (2000). Can book-to-market, size and momentum be risk factorsthat predict economic growth? Journal of Financial Economics, 57(2), 221–245. https://doi.org/10.1016/s0304-405x(00)00056-8.

Lintner, J. (1965). The valuation of risk assets and the selection of risky investments instock portfolios and capital budgets. The Review of Economics and Statistics, 47(1),13–37. https://doi.org/10.2307/1924119.

Lo, A.W., & MacKinlay, A.C. (1990). Data-snooping biases in tests of financial asset pricing models. Review of Financial Studies, 3(3), 431–467. https://doi.org/10.1093/rfs/3.3.431.

MacKinlay, A. (1995). Multifactor models do not explain deviations from the CAPM. Journal of Financial Economics, 38(1), 3–28. https://doi.org/10.1016/0304-405x(94)00808-e.

Merton, R.C. (1973). An Intertemporal capital asset pricing model. Econometrica, 41(5),867–887. https://doi.org/10.2307/1913811.

Miller, M.H., & Scholes, M.S. (1982). Dividends and taxes: Some empirical evidence. Journal of Political Economy, 90(6), 1118–1141. https://doi.org/10.1086/261114.

Narayan, P.K., & Ahmed, H.A. (2014). Importance of skewness in decision making: Evidence from the Indian stock exchange. Global Finance Journal, 25(3), 260–269. https://doi.org/10.1016/j.gfj.2014.10.006.

Narayan, P.K., & Bannigidadmath, D. (2015). Are Indian stock returns predictable? Journal of Banking & Finance, 58, 506–531. https://doi.org/10.1016/j.jbankfin.2015.05.001.

Pandey, A., & Sehgal, S. (2015). Explaining size effect for Indian stock market. Asia-Pacific Financial Markets, 23(1), 45–68. https://doi.org/10.1007/s10690-015-9208-0.

Pastor, L., & Stambaugh, R. (2001). Liquidity Risk and Expected Stock Returns. NBER Working Paper No. 8462. https://doi.org/10.3386/w8462.

Petkova, R. (2006). Do the Fama–French factors proxy for innovations in predictive variables? The Journal of Finance, 61(2), 581–612. https://doi.org/10.1111/j.1540-6261.2006.00849.x.

Pontiff, J., & Schall, L.D. (1998). Book-to-market ratios as predictors of market returns. Journal of Financial Economics, 49(2), 141–160. https://doi.org/10.1016/s0304-405x(98)00020-8.

Roll, R. (1977). A critique of the asset pricing theory’s tests part I: On past and potential testability of the theory. Journal of Financial Economics, 4(2), 129–176. https://doi.org/10.1016/0304-405x(77)90009-5.

Roll, R., & Ross, S. A. (1980). An empirical investigation of the arbitrage pricing theory. The Journal of Finance, 35(5), 1073–1103. https://doi.org/10.1111/j.1540-6261.1980.tb02197.x.

Rosenberg, B., Reid, K., & Lanstein, R. (1985). Persuasive evidence of market inefficiency. The Journal of Portfolio Management, 11(3), 9–16. https://doi.org/10.3905/jpm.1985.409007.

Ross, S.A. (1976). The arbitrage theory of capital asset pricing. Journal of Economic Theory, 13(3), 341–360. https://doi.org/10.1016/0022-0531(76)90046-6.

Roy, R. (2021). Is the six-factor asset pricing model discounting the global returns? Macroeconomics and Finance in Emerging Market Economies, 16(1), 95–136. https://doi.org/10.1080/17520843.2021.1936110.

Sehgal, S., & Balakrishnan, A. (2013). Robustness of Fama-French three factor model: Further evidence for Indian stock market. Vision: The Journal of Business Perspective, 17(2), 119–127. https://doi.org/10.1177/0972262912483526.

Sehgal, S., & Jain, K. (2015). Dissecting sources of price momentum: Evidence from India. International Journal of Emerging Markets, 10(4), 801–819. https://doi.org/10.1108/ijoem-04-2014-0046.

Sharma, G., Subramaniam, S., & Sehgal, S. (2019). Are prominent equity market anomalies in India fading away? Global Business Review, 22(1), 255–270. https://doi.org/10.1177/0972150918811248.

Sharpe, W.F. (1964). Capital asset prices: A theory of market equilibrium under conditionsof risk. The Journal of Finance, 19(3), 425–442. https://doi.org/10.2307/2977928.

Sobti, N. (2018). Does size, value and seasonal effects still persist in Indian equity markets? Vision: The Journal of Business Perspective, 22(1), 11–21. https://doi.org/10.1177/0972262917750230.

Tripathi, V., & Aggarwal, P. (2020). Is value premium sector-specific? Evidence from India. Managerial Finance, 46(12), 1605–1628. https://doi.org/10.1108/mf-02-2020-0049.

Vasishth, V., Sehgal, S., & Sharma, G. (2020). Size effect in Indian equity market: Mythor reality? Asia-Pacific Financial Markets, 28(1), 101–119. https://doi.org/10.1007/s10690-020-09318-0.

Veeravel, V. (2023). Short-term persistence performance of equity mutual fund returns: Evidence from India. Copernican Journal of Finance & Accounting, 12(3), 79–92. https://doi.org/10.12775/cjfa.2023.017.

Welch, I., & Goyal, A. (2007). A comprehensive look at the empirical performance of equitypremium prediction. Review of Financial Studies, 21(4), 1455–1508. https://doi.org/10.1093/rfs/hhm014.

Zaremba, A. (2015). The January seasonality and the performance of country-level value and momentum strategies. Copernican Journal of Finance & Accounting, 4(2),195–209. https://doi.org/10.12775/cjfa.2015.024.