Pricing Portfolios Constructed on Cyclicality Considerations Using Non-Domestic Regional Factors: Evidence from Eurozone Region
Abstract: This research paper tests the traditional market based pricing models and their ability to explain the return on portfolios constructed on cyclicality basis in the Eurozone region. The paper goes beyond the domestic market portfolios (indices) regularly used for asset pricing to the more regional or international approach of asset pricing through using regional market portfolios as a predictor factor as a potential indicator of the Eurozone economic integration level. The paper tests both conditional and unconditional asset pricing approaches using returns over two portfolios, Cyclical and Defensive, which contain the entire Eurozone equity market securities over the period between 2001 and 2012. Further we separate out test period in two economic cycle phases (expansion and recession) and three instability periods. Both non-conditional CAPM and Fama and French three factor models proved different kind of inefficiency to price portfolios based on cyclicality. Both CAPM and FF3M proved high pricing error (significant alphas) for the cyclical portfolio however insignificant pricing error (insignificant alphas) for the defensive portfolio during all total/recession/expansion periods. The STOXX Europe 600 proved to be a significant predictor variable for cyclical portfolios during all total/recession/expansion periods while very low statistically significance for defensive portfolios for all total/recession/expansion periods.
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