“van Rensburg P and E Janari (2008) “Firm Specific Attributes and the Cross-Section of Australian Stock Exchange Returns” Journal of Asset Management, vol 9, no. 3, 193-214”

Abstract: Recent investigations of the Sharpe (1964), Lintner (1965), Mossin (1966), and Black (1972) Capital Asset Pricing Model (CAPM) have identified numerous inconsistencies with the model’s predictions. A number of variables have displayed evidence of the ability to explain the cross-sectional variation in share returns beyond that explained by beta. This study sets out to ascertain the identity of these firm-specific characteristics over the period June 1994–May 2004 for members of the Australian Stock Exchange (ASX) All Ordinaries stock index. A data set including 207 firm-specific attributes is created for stocks in the sample and, with over 4.85 million observations, this is the largest set yet assembled for a study on the ASX. Using the Fama and Macbeth (1973) cross-sectional regression approach, attributes are tested for the ability to explain the cross-sectional variation in ASX share returns beyond that explained by the CAPM and a principal components-derived APT model. Similar significant characteristics are found when unadjusted and both sets of risk-adjusted returns are examined. The set of significant characteristics derived from the unadjusted returns test is then simplified using correlation analysis and an agglomerative hierarchical clustering algorithm, resulting in a list of 27 variables that are not highly correlated with each other. The existence of anomalies found in prior Australian literature (size, price-per-share, M/B, cashflow-to-price, and short- to medium-term momentum) is confirmed. As these previously documented anomalies only comprise five of the final simplified list of 27 significant characteristics, this paper identifies 22 previously undocumented Australian anomalies. The 27 significant style characteristics are then used to construct a multifactor model that comprises a set of factors that are simultaneously statistically significant when cross-sectionally regressed on share returns. A five-factor characteristic-based model for the ASX is empirically derived, which comprises (1) prior 12-month return, (2) book-to-market value, (3) two-year percentage change in dividends paid, (4) cashflow-to-price, and (5) two-year percentage change in market-to-book value as explanatory variables.

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