The Swedish equity market: Anomalies and pricing contributions using portfolio sorting techniques

Abstract

The Capital Asset Pricing Model (CAPM) is a widely used tool to describe the risk-return relationship for stocks. Several studies focusing on asset pricing have during the last decades indicated that the one-factor model CAPM is associated with limitations to explain the cross-sectional and time variation in expected stock returns. Furthermore, the returns of stocks has been suggested to, at least partly, be driven by anomalies. Multi-factor pricing models, such as the Fama French three-factor and the Carhart four-factor models, are therefore considered as suitable alternatives to more accurately capture the risk and return trade-off. This master’s thesis used portfolio sorting techniques and statistical analyses to evaluate the importance of a broad suite of explanatory variables related to asset returns. Book value of leverage, size, book-to-market ratio, price-to-earnings ratio, return on asset, return on equity, and the investment-to-asset ratio were used to describe the risk and return trade-off in the Swedish equity market during the sample period 2004-2017. Results from portfolio sorting supported significant positive correlations between stock returns and the book-to-market ratio, return on asset, and return on equity, respectively. Further, a significant negative correlation between price-to-earnings ratio and stock return was observed. Although not statistically significant in the portfolio sorting, investment-to-asset ratio was significantly negatively correlated with stock returns for the value-weighted portfolios after the market factors from the Carhart four-factor model were taken into account. In contrast, the variables leverage and size were not able to predict cross-sectional differences in stock returns on the Swedish market over the period studied.