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Can we treat empirical regularities as state variables in the ICAPM? Evidence from Australia

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  • Docherty, Paul
  • Chan, Howard
  • Easton, Steve

Abstract

By examining the correlation between the size, value and momentum empirical regularities and macroeconomic variables we investigate whether these regularities may be explained as risk factors within Merton's (1973) ICAPM. We examine the commodity-based Australian economy where financial asset claims are highly sensitive to macroeconomic volatility. The size and momentum premia covary pro-cyclically, while the value premium is countercyclical and negative at the business cycle peak. All three regularities become insignificant after controlling for the Chen et al. (1986) factors and a macroeconomic model successfully forecasts returns for both the size and momentum premia. Our results suggest that these regularities may be explained as macroeconomic-risk factors. We argue that covariance between macroeconomic risk and empirical regularities may explain inconsistencies in prior Australian market literature.

Suggested Citation

  • Docherty, Paul & Chan, Howard & Easton, Steve, 2013. "Can we treat empirical regularities as state variables in the ICAPM? Evidence from Australia," Pacific-Basin Finance Journal, Elsevier, vol. 22(C), pages 107-124.
    • Handle: RePEc:eee:pacfin:v:22:y:2013:i:c:p:107-124
    DOI: 10.1016/j.pacfin.2012.10.004
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    2. Canh P. Nguyen & Christophe Schinckus & Thanh D. Su & Felicia H. L. Chong, 2022. "Determinants of stock market returns in emerging markets: The linkage between institutional quality and macro liquidity," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 27(4), pages 4472-4486, October.
    3. Alexandre Ripamonti & Raphael Videira & Denis Ichimura, 2020. "Asymmetric information and daily stock prices in Brazil," Estudios Gerenciales, Universidad Icesi, vol. 36(157), pages 465-472, December.

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    More about this item

    Keywords

    Asset pricing; Fama–French model; Macroeconomic risk; ICAPM;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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