A New Measure of Asset Pricing: Friction-Adjusted Three-Factor Model

Abstract

In unfrictionless markets, one measure of asset pricing is its height of friction. This study develops a three-factor model by loosening the assumptions about stocks without friction, without risk, and perfectly liquid. Friction is used as an indicator of transaction costs to be included in the model as a variable that will reduce individual profits. This approach is used to estimate return, beta and other variable for firms listed on the Indonesian Stock Exchange (IDX). To test the efficacy of friction-adjusted three-factor model, we use intraday data from July 2016 to October 2018. The sample includes all listed firms; intraday data chosen purposively from regular market are sorted by capitalization, which represents each tick size from the biggest to smallest. We run 3,065,835 intraday data of asking price, bid price, and trading price to get proportional quoted half-spread and proportional effective half-spread. We find evidence of adjusted friction on the three-factor model. High/low trading friction will cause a significant/insignificant return difference before and after adjustment. The difference in average beta that reflects market risk is able to explain the existence of trading friction, while the difference between SMB and HML in all observation periods cannot explain returns and the existence of trading friction.

Impact of COVID-19 on Performance Evaluation Large Market Capitalization Stocks and Open Innovation

“…The Sharpe index evaluates average excess returns during volatility [ 14 ]. The average volatility of excess profits is measured by SD [ 5 ]. The Sharpe ratio method is stated in the following formula: Average excess return volatility is measured by the SD of excess returns [ 14 ].…”

“… Treynor Ratio The Treynor ratio is a model used to evaluate stock performance by calculating the portfolio risk premium per unit market risk (beta). Market risk as a systematic risk, or often called beta, cannot be eliminated through diversification, that is, a trend regression of portfolio returns formed in market portfolios [ 5 , 18 ]. The Treynor Ratio formula is as follows [ 17 ]: where T = The Treynor Index; i = The beta of the stocks.…”

“…Liu et al [ 4 ] found that in major economies, stock markets have been affected and have dropped dramatically since the start of the COVID-19 pandemic, including countries in Asia with more negative abnormal returns than other countries. The disasters that occur have an impact on the difficulty of operational financing, increased capital costs, and tightened financial flexibility [ 5 ]. They respond to COVID-19 macroeconomic shocks through underpricing of equity risk and reducing leverage.…”

Analysis of LQ45 share portfolio on Quadrimester I during the Covid-19 pandemic

“…This study supports previous research, namely research conducted by Sirait et al (2012) showing that there is a significant difference in the average abnormal return before and after the event. Nurhaeni (2009) shows that there is a significant difference in the average stock trading volume activity before and after the event. Sari, et al (2017) state that there is a significant difference in the average trading volume before and after the 2016 US presidential election.…”

“…Every investor invests his/her funds in a portfolio to get maximum return with lower risk (Poornima & Remesh 2016). The optimal portfolio is a portfolio with the best combination of expected returns and risks (Jogiyanto, 2015: 367;Nurhayati & Endri, 2020).…”