Testing index-based models in U.K. stock returns

J. Davies, Jonathan Fletcher and Andrew Marshall ()

Review of Quantitative Finance and Accounting, 2015, vol. 45, issue 2, 337-362

Abstract: We examine whether index-based models similar to Cremers et al. (Crit Financ Rev 2:1–48, 2012 ) are more effective in explaining cross-sectional U.K. stock returns than the more traditional Fama and French (J Financ Econ 33:3–56, 1993 ) and Carhart (J Financ 52:57–82, 1997 ) factor models using the two-pass cross-sectional regression approach. We find that the seven-index model has the highest cross-sectional R 2 across all models. However the superior performance of the seven-index model relative to the Fama and French ( 1993 ) and Carhart ( 1997 ) models is not robust in the multiple model comparison tests of Kan et al. (Rev Financ Stud 22:3449–3490, 2013 ). For these models and a conditional version of the Fama and French ( 1993 ) model, we cannot reject the null hypothesis that these models perform as least as well as the other competing models. In contrast, the four-index model of Cremers et al. ( 2012 ) performs poorly relative to the competing models. Our results suggest there is little benefit in using the seven-index model as an alternative to the Carhart ( 1997 ) model in practical applications that require the estimation of expected returns. Copyright Springer Science+Business Media New York 2015

Keywords: Index-based models; Cross-sectional R 2; Model misspecification; G11; G12 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (5)

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DOI: 10.1007/s11156-014-0439-3

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