Is there a priced risk factor associated with conservatism?
Abstract
Purpose
García Lara et al. (2011) argue that there is a conservatism-related priced risk factor in US stock returns. To put this to the test, the authors aim to analyze whether the conditional conservatism effect comes from the loading on a conditional conservatism-related factor-mimicking portfolio (systematic risk) or the conservatism characteristic itself.
Design/methodology/approach
The authors form characteristic-balanced portfolios from dependent sorts of stocks on the firm’s degree of conservatism and the firm’s loading on the conservatism-related factor-mimicking portfolio as proposed by Daniel and Titman (1997) and Davis et al. (2000).
Findings
The tests indicate that it is the conditional conservatism characteristic rather than the factor loading that explains the cross-sectional differences in average stock returns. Consequently, they do not find evidence for a conservatism-related priced risk factor.
Originality/value
This finding suggests that investors misvalue the conservatism characteristic and casts doubt on the rational risk explanation as proposed by García Lara et al. (2011).
Keywords
Acknowledgements
This research was conducted while Kerstin Lopatta was visiting professor at City University of Hong Kong and Christian Fieberg was substitute professor at the University of Bremen and lecturer at the FOM Hochschule. The authors wish to thank anonymous referees for helpful comments.
Citation
Lopatta, K., Canitz, F. and Fieberg, C. (2016), "Is there a priced risk factor associated with conservatism?", Journal of Risk Finance, Vol. 17 No. 5, pp. 545-561. https://doi.org/10.1108/JRF-05-2016-0065
Publisher
:Emerald Group Publishing Limited
Copyright © 2016, Emerald Group Publishing Limited