Modelling Sector-Level Asset Prices

32 Pages Posted: 20 Sep 2017

See all articles by Daniel J. Tulloch

Daniel J. Tulloch

University of Oxford - Smith School of Enterprise and the Environment

Ivan Diaz-Rainey

University of Otago - School of Business

I. M. Premachandra

University of Otago - Department of Accountancy and Finance

Date Written: September 18, 2017

Abstract

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

Tulloch, Daniel James and Diaz-Rainey, Ivan and Premachandra, I. M., Modelling Sector-Level Asset Prices (September 18, 2017). Available at SSRN: https://ssrn.com/abstract=3038712 or http://dx.doi.org/10.2139/ssrn.3038712

Daniel James Tulloch (Contact Author)

University of Oxford - Smith School of Enterprise and the Environment ( email )

United Kingdom
1865614934 (Phone)

Ivan Diaz-Rainey

University of Otago - School of Business ( email )

Dunedin
New Zealand

I. M. Premachandra

University of Otago - Department of Accountancy and Finance ( email )

PO Box 56
Dunedin, 9054
New Zealand

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