The Impact of Beta-Uncertainty on Asset Prices Saudi Empirical Evidence and Analysis

Abstract

This study estimates a six-factor empirical asset pricing model that instructed by the three- factor model of Fama and French (1992) and the theoretical framework of (Armstrong et al., 2013). The six factors of the model are the three typical risk factor loadings identified in Fama and French (1992) and the three respective uncertainties involved in estimating those loadings. The primary objective of the study is to investigate and document the impact of the uncertainties of factor loadings on contemporaneous stock returns in the Saudi capital market as per the theoretical framework of Armstrong et al. Throughout this study, the term factor loading uncertainty, also referred to as beta uncertainty, is defined as the uncertainty associated with estimating a particular factor loading or quantity of risk. In addition to the CAPM’s covariance risk, the influential model of Fama and French identifies two more factors associated mainly with the excess returns of the small stock portfolio over the large stock portfolio (SMB) and the excess returns of the high book-to- market portfolio over the low book-to-market portfolio (HML). The study answers its main research questions by measuring and testing the individual impacts of the market factor loading uncertainty, SMB factor loading uncertainty, and HML factor loading uncertainty on Saudi expected returns. Toward this end, the study strongly rejects the three null hypotheses of no impact and rather suggests a significant empirical impact (both individual and collective) of the three uncertainties of factor loadings. In particular, the study empirically reports that the individual parameter estimates corresponding to the respective three uncertainties are all negative and strongly statistically significant at traditional levels of the type I error. The study in this fashion has theoretical implications regarding resolving the widely documented anomaly that idiosyncratic volatility is negatively correlated with expected returns. The study also contributes to the extant literature by producing an international evidence on the subject while having relevance for evaluating the dynamics of asset prices in the Saudi capital market amid the ambitious 2030 vision and its endeavours of creating an economic environment of information transparency and market learning in Saudi Arabia.