Size, value and momentum in stock returns: evidence from India

Abstract

This paper examines the effects of size, value and momentum on the cross-sectional relation between expected returns and risk in the Indian stock market. We find that the conditional Carhart four-factor model empirically describes the variation of crosssection of return better than the unconditional model. When size, book-to-market and momentum effects are controlled in the conditional model, the positive relation of market beta, book-to-market and momentum with expected returns remains economically and statistically significant. However, this evidence is found to be subject to characteristics of test portfolios. The expected returns are sensitive to changes in predictive macroeconomic variables. IntroductionThe Capital Asset Pricing Model (CAPM) developed by Sharpe and Lintner has become an important tool in finance for the assessment of cost of capital, valuing investments, portfolio performance measurement and diversification among others. However, recent empirical research in finance focused on firm-specific characteristic or anomalies that explain the cross-section of expected return better than the traditional asset pricing models. Fama and French (1993) propose a three-factor asset pricing model to include small-minus-big size (SMB) and high-minus-low book-to-market (HML) risk factors with the traditional CAPM to capture size and value effect, respectively. Motivated by the Fama-French three-factor model, Carhart (1997) further improved the model by including winners-minus-losers momentum (WML) factor to capture momentum effect with the three-factor model. In light of the recent developments and issues on asset pricing, there are many empirical researches on size, value and momentum effects in the developed stock market especially in the US. Despite the facts that emerging stock markets constitute a significant share of the world equity market, it has received less attention in this regard. There is a discrepancy in the domestic investor's participation rate, equity premium and risk in emerging markets against developed market like the US (Bekaert and Harvey 2013; Giannetti and Koskinen 2010). As the capital market of these markets has become more integrated with regional and world markets, it is necessary to provide academics and practitioners a better understanding on the cross-sectional behaviour of stock returns in these markets. This study is an attempt to address this issue in the Indian context. Indian markets have experienced a phenomenal growth in the last two decades. The consequence

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