Re-examining risk premiums in the Fama–French model: The role of investor sentiment

Po-Chin Wu, Shiao-Yen Liu and Che-Ying Chen

The North American Journal of Economics and Finance, 2016, vol. 36, issue C, 154-171

Abstract: This paper reconstructs the Fama–French three-factor (F–F) model as a panel smooth transition regression (PSTR) framework to investigate the differentiated effects of investor sentiment proxies-the volatility index (VIX), credit default swap (CDS), and TED spread-on the three risk premiums. Sample period spans from 2003: 1Q to 2013: 4Q. Sample objects are 58 semiconductor companies listed on Taiwan Security Exchange Corporation. The empirical results report that stock returns display a nonlinear path, and the three risk premiums are time-varying, depending on different proxies of investor sentiment in different regimes. Market premiums fall as investors in stock markets show extreme optimism or extreme pessimism. Except in rare situations, the size premium is significant and decreases with the increase in the VIX. Returns in holding growth stocks dominate holding value stocks when the investors show extreme pessimism or optimism. However, in normal sentiment of investment, value stocks earn more returns than growth stocks.

Keywords: Fama–French model; Volatility index (VIX); Credit default swap (CDS); Treasury-Eurodollar (TED) spread; Panel smooth transition regression (PSTR) model (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:36:y:2016:i:c:p:154-171

DOI: 10.1016/j.najef.2015.12.002

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