The Impact of the Financial Sector on Asset Pricing Tests: Evidence from the Colombo Stock Exchange
Abstract
This paper aims to identify how the inclusion of financial sector affects the ability of asset pricing models to explain the average stock returns in the CSE. Most of the asset pricing researches, the firms in the financial sector are excluded on the basis that their characteristics and the leverage are notably different than firms in other industries. Therefore the objective of this study is to identify the impact of the inclusion of financial sector on the ability of the Carhart four-factor model to explain the average stock returns in the CSE and to compare its performance with the Capital Asset Pricing Model (CAPM) and the Fama and French three-factor model. The study finds that the four-factor model; incorporating the market premium, size premium, value premium and momentum premium provides a satisfactory explanation of the variation in the cross-section of average stock returns in the CSE, even when the financial sector is included. It is found that the Carhart four-factor model performs better than the CAPM in all scenarios; and that it performs notably better than the Fama and French three-factor model.However, there is no notable difference in the findings either the financial sector is included or not.
Submission of an article implies that the work described has not been published previously (except in the form of an abstract or as part of a published lecture or academic thesis), that it is not under consideration for publication elsewhere, that its publication is approved by all authors and tacitly or explicitly by the responsible authorities where the work was carried out, and that, if accepted, will not be published elsewhere in the same form, in English or in any other language, without the written consent of the Publisher. The Editors reserve the right to edit or otherwise alter all contributions, but authors will receive proofs for approval before publication.
Copyrights for articles published in MTI journals are retained by the authors, with first publication rights granted to the journal. The journal/publisher is not responsible for subsequent uses of the work. It is the author's responsibility to bring an infringement action if so desired by the author.
