Modelling Sector-Level Asset Prices

• Main Authors: Daniel J. Tulloch, Ivan Diaz-Rainey, I. M. Premachandra
• Format: Article
• Language: English
• Published: MDPI AG 2020-06-01
• Series: Journal of Risk and Financial Management
• Subjects: asset pricing; stock market; structural breaks; sector analysis
• Online Access: https://www.mdpi.com/1911-8074/13/6/120

We present a modelling approach for sector asset pricing studies that incorporates sector-level risk factors, subgroup portfolios, and structural breakpoint tests that are better at isolating the time-varying nature and the firm-specific component of returns. Our results show considerable subsector heterogeneity, while the asset pricing model using local risk factors and inductive structural breaks results in a superior model ( of 80.42% relative to of 68.79% of “conventional” models). Finally, we show that some of the variances of residuals, normally assumed to be the firm-specific component of returns, can be attributed to the changing relationship between sector returns and risk factors.