Pricing of Equities in China: Evidence from the Shanghai Stock Exchange

In this paper we compare the performance of the traditional CAPM with the multifactor model of Fama and French (1996) for equities listed in the Shanghai Stock Exchange. We also investigate the explanatory power of idiosyncratic volatility and respond to the claim that multifactor model findings can be explained by the turn of the year effect. Our results show that firm size, book to market equity and idiosyncratic volatility are priced risk factors in addition to the theoretically well specified market factor. As far as the turn of the year effect is concerned we reject the claim that the findings are driven by seasonal factors. Our findings have implications for both academic researchers and practitioners. This is because we demonstrate that by following the investment strategies investigated in this paper superior returns could be generated – returns in addition to those offered by the market. Of course this is only applicable to those investors who are willing to take additional risks in order to generate additional returns. In summary, our results show that a broader asset pricing model such as the one investigated in this paper does a much better job than the single index CAPM.