Three essays of Empirical Asset Pricing in the UK

Abstract

The first empirical chapter examines the existence of a “net equity issuance” (NEI) effect in the UK stock market. Net Equity Issuance (NEI) refers to the change in a firm’s shares outstanding due to events such as SEOs, acquisitions financed by share issues, issues to staff and share repurchases. The NEI effect is the ability of share issuance by firms to predict their subsequent stock returns. My results mainly suggest that there is an NEI effect in the UK. However, a discrepancy exists between the UK results and those found in the US. In the UK market, negative-NEI stocks tend to show negative subsequent returns while zero-NEI stocks have the highest subsequent returns. I also find that the abnormal returns from the NEI effect disappear when transaction costs are taken into account. Furthermore, the asset pricing test results suggest that the new factor models partially explain the NEI effect in the UK. The second empirical chapter evaluates the information content of new asset pricing factors in the UK. I find that two new risk factors, the investment factor and the profitability factor, improve the factor model’s performance in the UK while both the size factor “small minus big” (SMB) and the value factor “high minus low” (HML) are redundant. There is also evidence that factor construction methods matter to the information content of the profitability factor. The most informative profitability factor in the UK among the possible candidates is constructed using income before extraordinary items scaled by book equity. The third empirical chapter explores the information content of the two new factors by linking them to the state variables which predict future investment opportunities. By doing this, I find confirmative evidence that the two new risk factors may proxy for state variables that capture time variations in the investment opportunity set. I find empirical evidence which confirms that the investment factor predicts future economic growth, proxied by GDP growth, investment growth and consumption growth. In addition, the investment factor is found to be related to dividend yield shocks, whereas the profitability factor is related to inflation shocks. In addition, the pricing significance of macroeconomic variable shocks disappears when loadings on the two new factors are presented in the model. The evidence therefore provides economic interpretation to the information content of the new asset pricing factors in the UK market.