The conditional Fama-French model and endogenous illiquidity: A robust instrumental variables test

We investigate conditional specifications of the five-factor Fama-French (FF) model, augmented with traditional illiquidity measures. The motivation for this time-varying methodology is that the traditional static approach of the FF model may be misspecified, especially for the endogenous illiquidit...

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Bibliographic Details
Published in:PloS one Vol. 14; no. 9; p. e0221599
Main Authors: Racicot, François-Éric, Rentz, William F., Tessier, David, Théoret, Raymond
Format: Journal Article
Language:English
Published: United States Public Library of Science 18.09.2019
Public Library of Science (PLoS)
Subjects:
Algorithms
Analysis
Asset pricing
Book value
Commerce
Econometrics
Economic models
Economic statistics
Financial management
Humans
International finance
Investments
Markets
Methods
Models, Econometric
Motivation
Parameter sensitivity
Physical Sciences
Pricing
Research and Analysis Methods
Researchers
Risk assessment
Skewness
Social Sciences
Specifications
Variables
United Kingdom > UK
Canada
ISSN:1932-6203, 1932-6203
Online Access:Get full text
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Summary:We investigate conditional specifications of the five-factor Fama-French (FF) model, augmented with traditional illiquidity measures. The motivation for this time-varying methodology is that the traditional static approach of the FF model may be misspecified, especially for the endogenous illiquidity measures. We focus on the time-varying nature of the Jensen performance measure α and the market systematic risk sensitivity β, as these parameters are essentially universal in asset pricing models. To tackle endogeneity and other specification errors, we rely on our robust instrumental variables (RIV) algorithm implemented via a GMM approach. In this dynamic or time-varying conditional context, we generally find that the most significant factor is the market one, but illiquidity may matter depending on which states or estimation methods we consider. In particular, sectors whose returns embed a market illiquidity premium are more exposed to a binding funding constraint in times of crisis, which leads to deleveraging and a resulting decrease in systematic risk.
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Competing Interests: The authors have declared that no competing interests exist.
ISSN:1932-6203
1932-6203
DOI:10.1371/journal.pone.0221599