Idiosyncratic volatility as a new factor

Published: 11 May 2020| Version 1 | DOI: 10.17632/r7w3949m25.1
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Description

Under the research hypothesis of testing whether there is a significant relation between expected stock return and idiosyncratic volatility in emerging markets, we gathered 5-year daily return data on MSCI Emerging Markets Index constituents and investigated the prediction power of four type of asset pricing models (e.g. CAPM, 3-factor Fama-French, 4-factor Carhart and modified 5-factor Carhart model with idiosyncratic volatility (IVHML). We discovered, that the IVHML coefficient is significant in all testing periods, and the overall model better describes expected returns (Adj. R^2 is higher among all others).

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Steps to reproduce

In order to reproduce the five factors in Excel-file one should construct value-weighted portfolios, except MKT factor (Index Return-Risk-free rate): -SMB factor=(S/L+S/M+S/H)/3-(B/L+B/M+B/H)/3 -HML factor=(S/L+B/L)/2-(S/H+B/H)/2 -MOM factor=((S/W+B/W)/2)-((S/L+B/L)/2) -IVHML factor=IHML=((S/B+B/B)/2)-((S/S+B/S)/2) All returns are daily excess log-returns over risk-free rate.

Categories

Portfolio Choice, Portfolio Optimization, Educational Finance

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