Firm-specific attributes and the cross-section of JSE securities exchange returns

Doctoral Thesis


Permanent link to this Item
Journal Title
Link to Journal
Journal ISSN
Volume Title

University of Cape Town

The empirical counterpart of a theory of asset prices is a model of the cross-section of security returns. Empirical tests of the Capital Asset Pricing Model (CAPM) of Sharpe (1964), Lintner (1965), Mossin (1966) and Black (1972) using cross-sectional methodologies have identified numerous cases where variables apart from beta explain expected returns. Initially termed 'anomalies', these empirical violations of the theory are frequently associated with firm-specific attribute data. Traditional views of market efficiency however rule out the ability to predict risk-adjusted asset returns and the source and exploitability of these anomalies remains controversial. This thesis empirically investigates the cross-sectional relationship between twenty-four firm-specific attributes and stock returns on the JSE Securities Exchange (JSE). The results are evaluated to determine whether they conform to the predictions of the CAPM and a two factor Arbitrage Pricing Theory (APT) model suggested by prior research. In monthly univariate tests similar to Fama and MacBeth (1973), price-to-NAV, dividend yield, price-to-earnings, cashflow-to-price, price-to-profit and size are found to have statistically significant predictive power in the cross-section of returns using monthly data from July 1990 to June 2000. After conducting risk-adjustments using both the CAPM and a two factor APT model these effects are found to persist. Multivariate testing suggests a two factor model with the size and price-to-earnings attributes as explanatory variables. When the cross-sectional tests are compared across the broad industry sectors of the JSE, value effects are observed as being stronger in the financial-industrial sector than in the resource sector, the small size effect is roughly the same across sectors while the premium earned by higher debt levels is negative across all sectors except the financial sector. The results are not reconcilable with the predictions of the CAPM. Simulated portfolios constructed using a methodology similar to Fama and French (1992) reveal that beta, if anything, is inversely related to average returns on the JSE. Contrary to the international evidence, greater average returns accruing to small and low price-to- earnings firms are not commensurate with higher betas. Controlling for the small size and low price-to-earnings effects does not improve the explanatory power of beta. An application of the Daniel and Titman (1997) methodology suggests that average returns on the JSE are not compensation for factor risk, but instead are associated with the exposure to the attributes themselves. The findings of this study present a serious empirical challenge for covariance-based asset pricing models on the JSE.

Includes bibliographical references.