Team member

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Team member

• Team manager Lili Ma
• Speaker Liang Gao Chuan Sun
• Technical support Xiangyu Zheng
• Zhewei Gu

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The Effects of Beta ,Bid-Ask Spread ,Residual
Risk ,and Size on Stock Returns

• YAKOV AMIHUD and HAIM MENDELSON

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Background

• (i) Merton's Model
• According to the Capital Asset Pricing Model
  ,expected asset returns are determined solely by
  the systematic risk.
• Inconsistencies between the dictum of the
  theory and the empirical findings led Merton to
  suggest a more general model of asset pricing.

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Expected return in Merton's Model

• The expected return on each asset will be as
  follows
• (1) an increasing function of its systematic
  risk
• (2) an increasing function of its residual risk
  (due to imperfect diversification of this risk)
• (3) an increasing function of the fraction of the
  market portfolio invested in the asset, which can
  be measured by the asset's value or size
• (4) a decreasing function of the fraction of all
  investors who buy the asset, reflecting public
  availability of information about the asset.

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(ii) A-M's Model

• An asset-pricing model which focuses on
  the role of illiquidity, measured by the bid-ask
  spread, was suggested by Amihud and Mendelson.
• In this model, assets have bid-ask
  spreads which reflect their transaction (or
  illiquidity) costs, and investors have
  heterogeneous liquidation plans or holding
  periods.

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(iii) The Bid-ask spread

• (1)The bid-ask spread is related to the
  number of investors holding the asset, by Merton,
  reflects the availability of information about
  it.
• (2)The bid-ask spread is also related to the
  residual risk.

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(iv) The Main Task

• Carry out a well specified test of these
  relations jointly for all four explanatory
  variables .

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2. Testing Hypothesis
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Introduction to CAPM

• Is the classical theory consistent with the
  empirical findings?

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Probably Related Variables

• Portfolio Beta
• Portfolio Standard Deviation
• Portfolio Average Spread
• Average Market Value of Stocks in
  Portfolio
• Average Monthly Excess Return of Portfolio

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Data Methodology

• Data Range
• Monthly series over 19611980
• Methods
• Using Pooled Cross-Section Time-Series
  Estimation

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Steps

• 1) Estimate stocks coefficients from
  previous data using market model
• 2) Form 49 ptfs according to spread and then
  according to the value of
• 3) Calculate probably related variables of each
  ptf
• 4) Estimate cross-sectional relation

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Results 1Correlation
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Results 2Regression

• DYnDummy Variables ( denoting the differences
  between the years)

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Results 2Significance

• OLS Results

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Results 3

• GLS Results

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Results 3

• Principal factors affecting asset returns are
  the Beta risk and Illiquidity (Bid-ask Spread)
• The hypotheses on the effects of size and
  residual risk are not supported

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Contributions

• Joint Estimation of effects of all four variables
  are superior to those obtained when a partial set
  of variables is included.

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Conclusion

• Results support the hypotheses expected return
  is an increasing function of ßand bid-ask spread
• but do not support the hypotheses on the
  effects of residual riskdand firm size

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Conclusion

• The effect of residual risk can be reduced by
  investor because of diversification
• but the effect of illiquidity is
  nondissipative because it is hardly eliminated by
  investors
• firms have an incentive to increase the liquidity
  of their financial claims

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• Thanks for your attention!
• Thanks for our tutor- Peter N Smith!
• Thanks for the time weve been together!
• Thank you!