Asset pricing anomalies, risk factors and their application

Abstract

This thesis is built around the development and use of asset pricing factors and addresses pricing anomalies. It investigates the idiosyncratic volatility (IV) anomaly in China and applies the resale option theory first documented by Scheinkman and Xiong (2003). The research confirms that the IV anomaly in China and shown that the resale option theory can be quite helpful in deciphering the IV effect. Confirmation of the IV anomaly in China is a contribution to current literature; more importantly, the adoption of resale option theory to explain the IV effect in China is believed to be new. It also investigates the impact of being a state-owned enterprise (SOE), it shows that the SOE factor is useful in understanding of the asset pricing mechanism in China. The construction of an SOE factor and the concept of building a “true-to-label” risk factor by neutralizing the SOE effect are new contributions. This thesis investigates how risk-factor premia can be captured when investments are restricted to long-only positions (i.e., securities can only be purchased, not sold, short). Further it extends the asset pricing factor portfolio using a multifactor rotation technique, with the goals of isolating the cyclicality of the factor’s behavior and varying its exposure to different factors to improve the return, also with long-only constraints.