Factors Influencing The Cost Of Capital

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Introduction The popularity of three factors model raised by Fama and French in 1993 has been subject to controversy among the scholars with regard to adoptability of this price model in variable stock markets. I survey the most recent literatures and re-explore the persistence of size factor in US and other stock markets in the first section and further discuss the economic reason for incorporation of size factor in the second section. I am interested in examining the size factor for two reasons. Firstly, there has always been disparity with regard to the persistence of the size factor in literature. Secondly, the discussion has a strong practical implication in constructing asset pricing model and determining the cost of capital.…show more content…
Ferson and Harvey (1999) queried the performance of FF three factor model under different conditions and raised dynamic factor pricing model (DFPM). Carhart proposed the four factors model including the momentum factor in 1997. Griffin (2002) separated and studied usefulness of country-specific and international component of FF three-factor model and found country-specific versions are more useful at explaining time series variation in portfolios. Even though used to be the constructive break-through at that moment, their findings were made from obsolete data. In this paper. I explore the empirical results of recent literatures to re-examine if size factor is still well performed in current broader markets. US market Empirical results in US market of recent literature have manifested that size factor are less influential. Israel and Moskowitz suggested no strong evidence of size premium was found over the entire sample period of 1927 to 2011 by investigating both long only and long-short portfolios. But he further hypothesized the interaction between firm size and value and momentum factor. This is consistent with Cakici and Tan where a positive, but statistically insignificant size effect in US market as illustrated below. Fama and French (2012) also reported insignificant size premium by grouping countries into four territorial regions. Ahn, Min and Yoon
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