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Security returns, beta, size, and book-to-market equity: evidence from the Shanghai A-share market

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Abstract

The main purpose of this paper is to explore the cross-sectional relationship between security returns and beta, size and book-to-market equity in the Shanghai A-share market. This study takes place during the period January 1997–December 2006. The methodology of Fama and French (J Finance 51:55–84, 1992) and Pettengill et al. (J Financial Quant Anal 30:101–116, 1995) is adopted. The Results show no evidence of an unconditional relationship between beta and returns. However, a conditional relationship is found when the data is split into up and down markets. The relationship holds even in the presence of size and book-to-market equity. Both size and book-to-market equity is found to be priced by the market and thereby regarded as significant determinants of security returns.

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Notes

  1. Subsequent studies based in the US market by Grinold (1993), Davis (1994) and Fama and French (1995, 1996) provide additional evidence against an unconditional relationship between beta and returns.

  2. Studies outside of the US and European markets include; Ho et al. (2000) and Lam (2001) in the Hong Kong market, Faff (2001) in the Australian market, and Sandoval and Saens (2004) examining the markets of Argentina, Brazil, Chile and Mexico. All these studies fail to find an unconditional relationship between beta and returns.

  3. Studies by Chan and Chui (1996) and Morelli (2007) on the UK market, and Lilti and Montagner (1998) on the French market failed to find a relationship between size and average returns.

  4. The methodology of Pettengill et al. (1995) can be adopted to test the significance of beta as a risk measurement. It is not a test of the CAPM, for the CAPM does not state what the ex-post relationship between risk and return should be.

  5. Further studies by Isakov (1999), Faff (2001), Lam (2001), Elsas et al. (2003) and Sandoval and Saens (2004), studying the Swiss, Australian, Hong Kong, German and Latin American markets respectively, all provide evidence in support of beta as a significant risk measurement when applying the Pettengill et al. (1995) methodology.

  6. The Chinese government, by allow investors outside of China to invest in the A-share market, has commenced the process of integration with other major global markets. During 2005 the Chinese government began a programme to increase the number of A-shares available for trading thereby starting a process to reduce government ownership. Restrictions do still exist, such as foreign investment restrictions, that impede the integration process.

  7. Prior to the opening of the B-share market to domestic Chinese investors there existed significant price differential between A and B-shares. A study by Yeh et al. (2002) found that the price premium with respect to A-shares had a significant influence on the return on both A and B-shares. Price differentials still exist, though to a lesser extent, due to the fact that foreign investors of B-shares require a greater return than Chinese investors in A-shares given that foreign investors expect to be compensated for the political risk associated with investing in China. An empirical study by Zhang and Zhao (2003) found that international investors respond differently to the political risk that exists within China. Clearly other factors in addition to political risk, such as differences in liquidity, information availability, economic risk, all contribute to the price differential.

  8. The time period of this study incorporates the Asian financial crisis of 1997–1998, often referred to as the IMF (International Monetary Fund) crisis. The financial crisis represented a period of economic turmoil that effected currencies and stock markets. The main Asian countries effected were; Hong Kong, Indonesia, Malaysia, Philippines, South Korea and Thailand. Mainland China was virtually unaffected thus the Asian crisis does not have any real impact for this study.

  9. The sample period commences in January 1997, for given that all tests are conducted using portfolios it is necessary to have enough securities in the A-share market in order to construct sufficient portfolios to run the cross–sectional regressions. Prior to this period the number of securities in various years was to low.

  10. This approach was first adopted by Fama and MacBeth (1973).

  11. The rational behind Pettengill et al. (1995) approach is the recognition that the risk-return relationship of the CAPM is one based on expected returns and not realised returns. The expectation is that the excess market return will always be positive, as discussed in Sect. 1, however the realised excess market return will at times be negative. The Pettengill et al. (1995) methodology recognises this and thus segments the data depending upon whether the excess market return is positive or negative, and then tests the beta-return relationship conditionally upon the sign of the excess market return.

  12. See studies by Black et al. (1972), Fama and MacBeth (1973).

  13. By assigning portfolio betas to individual securities permits tests to be performed using individual securities rather then portfolios. This provides two advantages, firstly it improves the statistical power of the test due to the larger data available, and secondly it prevents the dilution of size and book-to-market equity variables given that these are available for each security.

  14. Size-beta portfolios allow for variations in beta that are not related to size.

  15. The βi in all subsequent equations signifies the portfolio beta assigned to each security within its corresponding portfolio.

  16. The finding that pre-ranking betas capture the ordering of post-ranking betas, and also that post ranking betas vary positively with size is also consistent with UK studies by Chan and Chui (1996) and Morelli (2007).

  17. As discussed in Sect. 1, the A-share market consists of tradable and non tradable shares. The average monthly return (based on a value weighted portfolio) and the beta of the non-tradable shares in the sample is 0.86% and 0.81 respectively.

  18. Studies by Strong and Xu (1997), Fletcher (1997) and Morelli (2007) on the UK market all find beta to be an insignificant risk measurement.

  19. A significant positive relationship is also found in UK studies by Chan and Chui (1996) and Morelli (2007).

  20. Such findings are not consistent with UK studies by Chan and Chui (1996), Strong and Xu (1997), Fletcher (1997) and Morelli (2007).

  21. These findings are consistent with Fletcher (1997), Lau et al. (2002) and Morelli (2007).

  22. The study by Wang and Di Iorio (2007) define up markets as all months with a positive market return and down markets all months with a negative market return. They do not use market excess returns. It is therefore possible that various months may well have had a negative market risk premium though were included in up market data (a positive market return though less than the risk free rate). The difference in defining an up and down market may well explain the differing conclusions with respect to beta drawn from this paper to that of Wang and Di Iorio (2007).

  23. An analysis of the monthly seasonality in the relationship between returns and beta, size, and book-to-market equity is also examined (Results not reported though available upon request). It is found that the results shown in Tables 2 and 3 are not due to any abnormal seasonal observations, thus supporting the argument that any premium payments found represent risk payments.

  24. Fletcher (1997) on examining the UK market also produces similar findings regarding the symmetry hypothesis, which he describes as puzzling.

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Morelli, D. Security returns, beta, size, and book-to-market equity: evidence from the Shanghai A-share market. Rev Quant Finan Acc 38, 47–60 (2012). https://doi.org/10.1007/s11156-010-0218-8

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