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Prior research in Indian equity market has failed to fully document the well-known
influences of size and book-to-market effects that have been evidenced in other
markets. So, the question remains as to whether value premium exists in India or
whether it has simply failed to be adequately explored. Moreover, no robustness check
has been performed on this. This study uses buy-and-hold strategy for a short span
of one quarter to a relatively longer span of two years over the 10-year period from
June 2003 to September 2013 and finds no evidence of value premium in the Indian
market. This explains the presence of an anomaly as the results are contrary to what
have been found in other countries.
Introduction
Determinants of share price movements are one of the key concerns for researchers in the
field of Finance. The earlier studies have developed single-factor models and multi-factor
models in order to explain such movements. The groundbreaking work of Fama and French
(1992) shifted the focus on several key factors, including size and book-to-market ratio.
Prior researches in the area have largely been confined to the US market may be because
of accurate data availability regarding equity prices and company-specific financial
information. Using Indian data, only a few studies have been performed, and mostly these
are limited in depth and time series coverage.
A few studies have attempted to test the three-factor model in India. The results have
been found to be mixed and generally weak as compared to the US findings. For instance,
Bahl (2006) tests the three-factor model using 79 stocks listed in BSE-100 stock market
index, while Connor and Sehgal (2001) study the three-factor model using data of 364
companies from the June 1989 to March 1999. These studies find evidence that the three-
factor model suggested by Fama and French (1992) explains returns better than the traditional
Capital Asset Pricing Model (CAPM), but the results are not so much conclusive. For example,
there is mixed evidence for parallel market, size and book-to-market factors in earnings of
* Doctoral Student (Finance and Accounting), Indian Institute of Management, Lucknow, IIM Road,
Lucknow 226013, Uttar Pradesh, India; and is the corresponding author. E-mail: fpm13005@iiml.ac.in
** Professor (Finance and Accounting), Indian Institute of Management, Lucknow, IIM Road, Lucknow
226013, Uttar Pradesh, India. E-mail: madhu@iiml.ac.in
54 2015 IUP. All Rights Reserved. The IUP Journal of Applied Economics, Vol. XIV, No. 2, 2015
stocks in India. The findings of the said studies indicate about (negative) size premium and
insignificant (positive) value premium, although robustness check has not been performed.
This study, to the best of our knowledge, presents the first comprehensive examination
of the presence of value premium in the Indian market. The paper is structured as follows:
it reviews the existing literature available in this context, followed by the discussion of data
and methodology used in the study. Subsequently, the results are documented with analysis,
and finally, conclusion is offered.
Literature Review
The seminal study by Fama and French (1992) posits that there are a few factors which are
capable of explaining variation in equity returns. They successfully analyze the influence and
association of different key attributes on portfolio returns. Among a number of factors, two
have become generally accepted and widely used. They are: size and book-to-market ratio.
The relationship between size of a firm and corresponding returns is well documented in
literature. Banz (1981) is the first to describe an inverse relationship between market value
of equity and returns. Returns to the smaller sized firms significantly outperform returns of
the larger size stock. Beedles et al. (1988) find that the size premium is more pronounced in
Australia.
In addition to size and beta, Fama and French (1992) introduce book-to-market ratio as
a distinguishing factor for explaining returns. Specifically, they show that portfolios formed
on the basis of serially ranked book-to-market ratios exhibit differential performance. Portfolios
comprising firms with high book-to-market ratios usually outperform portfolios which
comprise firms with low book-to-market ratios. This is termed as value premium. This is
because firms with high book-to-market ratios have their value embedded in their book
valuation, whereas firms with low book-to-market ratios have their value embedded in market
expectations of future growth opportunities.
Fama and French (1993) argue that these two variables, size and book-to-market ratio,
can be interpreted as the pricing factors. This claim has been criticized due to lack of
theoretical justification (Lakonishok et al., 1994; Daniel and Titman, 1997; Daniel et al.,
2001; and Brennan et al., 2004). Moreover, there are criticisms on data snooping too (Black,
1993; Kothari et al., 1995; and Haugen and Baker, 1996). However, numerous studies have
established the relevance of size and book-to-market factors in the US equity market. These
factors are relevant to explain variations in stock returns (Fama and French, 1996 and 2006;
Barber and Lyon, 1997; Davis et al., 2000; and Griffin, 2002).
Studies on international data have been harder to conduct because book values over a
long time series are generally not available. The study by Chui and Wei (1998) on the data of
Asia-Pacific region has found supportive evidence for the same. In Australia, Halliwell
et al. (1999) attempt to test the Fama-French three-factor model. The results of their study
fail to support value-growth premium. Thereafter, Gaunt (2004), Durand et al. (2006), and
Objectives
The purpose of this study is twofold. First, the paper attempts to find out whether value
premium exists in Indian stock market. Second, it also tries to explore the minimum time
period required to observe such value effect. The subsequent analysis in this study focuses
on complete robustness checking of the existence of value premium over different durations
quarterly, half-yearly, three-quarterly, yearly and bi-yearly.
Portfolio Returns
We now explore the return performance of the 25 portfolios formed based on size and PB
ratio. We create five new portfolios as Value Minus Growth (VMG) within each size quintile.
The new VMG portfolios represent the size-adjusted value premium as they are formed
from the difference between the return of the value portfolio less the return of the growth
portfolio within each size quintile.
Table 2 presents the one period (one quarter) ahead mean monthly returns, standard
deviation of monthly returns and t-statistics of each of the 25 size-PB portfolios and five
VMG portfolios. It is observed from Table 2 that there are no significant differences in
returns of any of the size quintile, while moving from growth to value portfolios. The
t-statistic in Panel A shows whether the VMG portfolio has a mean return significantly
different from zero across all size quintiles. It clearly indicates that there are no significant
differences between the mean monthly returns for any of the size quintiles. Negative value
premium has been found in all portfolios irrespective of size quintile which is very much
unexpected and contrary to the results found in other countries. However, all of those
premiums across the size quintiles are found to be negligible and statistically insignificant.
Panel B of Table 2 depicts the standard deviation of returns on each of the portfolios.
These results show that the five PB portfolios have more or less similar volatility in returns
within each size quintile. However, as size declines the standard deviation increases across
all PB portfolios. So, there is a strong evidence of general pattern of smaller size portfolios
having higher volatility in returns. Among the various other arguments for this judgment is
the observation that small stocks have a lower price per share. This implies that small stocks
are more likely to exhibit higher volatility because a small variation in price leads to a higher
percentage change.
Tables 3 to 6 depict the two periods (half year), three periods (three quarters), four
periods (1 year) and eight periods (2 years) ahead mean monthly return of the stocks in six
different portfolios including VMG portfolio. Results similar to that of Table 2 have been
found in Panel A as well as in Panel B of the Tables 3 to 6. All of the value premiums across
the size quintiles of different time periods are found to be negligible and statistically insignificant.
Moreover, in all cases, standard deviation of returns are found to be similar within each size
quintile. However, they are increasing across all the PB portfolios.
In summary, the results indicate that there is no evidence of presence of value premium
in India in short or long run once we control for size effects. Hence, it is possible that there
is presence of an anomaly in this issue and the stock market of India operates differently as
compared to those of other countries.
Conclusion
Studies of overseas markets, particularly those of the US, have documented the significant
influence of book-to-market effects on equity returns. Researches in Indian market fail to
document similar findings. Moreover, no robustness checking is performed in those studies.
This study remedies these problems by examining the presence of value effect while employing
a buy-and-hold strategy for a short span of one quarter to a relatively longer span of two
years over the 10-year period from June 2003 to September 2013.
Using two independent sorts (portfolios are sorted according to their size and PB ratios),
no evidence of value effect is found across portfolios in Indian market. So, there is no
significant difference in returns between high and low price-to-book portfolios after controlling
for size.
This evidence is quite important for a number of reasons. First, the findings appear to
settle the question in dispute as to whether the value premium is present in the Indian market.
Second, the findings expose variability in standard deviations across portfolios. This has
implications for the economic significance of trading strategies based on value philosophies.
Finally, the use of a clean dataset avoids any criticism of data snooping and therefore the
study improves the comparative evidences across international equity markets.
Reference # 05J-2015-04-04-01