Modelling Sector-Level Asset Prices
32 Pages Posted: 20 Sep 2017
Date Written: September 18, 2017
We present a modelling approach for sector asset pricing studies that incorporates sector-level risk factors, sub-group portfolios, and structural break point tests that are better at isolating the time-varying nature and the firm-specific component of returns. The sub-group portfolios show considerable subsector heterogeneity, while the asset pricing model using local risk factors and inductive structural breaks results in a superior model (R2 of 80.42% relative to R2 of 68.79% of ‘conventional’ models). Finally, we show that 28% of the variance of residuals, normally assumed to be the firm-specific component of returns, can be attributed to the changing relationship between sector returns and risk premia.
Keywords: Sector-Level, Asset Pricing, Stock Market, Structural Breaks
JEL Classification: G12, G38, C51, Q40
Suggested Citation: Suggested Citation