Explaining Anomalies in Australia with a Five‐factor Asset Pricing Model

• DOI: http://doi.org/10.1111/irfi.12125
• Date: 01 March 2018
• Published date: 01 March 2018

Explaining Anomalies in Australia

with a Five-factor Asset Pricing

Model*

THANH D. HUYNH

Department of Banking and Finance, Monash Business School, Monash University,

Caulfield East, Victoria, Australia

ABSTRACT

This paper compares the ability of three-factor and five-factor asset pricing

models to explain the apparent profitability of a broad selection of anomalies

in Australian equity returns. Rather than examining the fit of each model to

common test portfolios, our focus is on the spread return to long–short

trading strategies designed around so-called anomalies. After documenting

significant spread returns to 16 anomalies (including several not previously

studied in Australia), the empirical analysis provides cautious support that

the recently-proposed investment and profitability factors have a role to play.

The number of anomalies that remains after risk adjustment decreases under

the five-factor model. Further, while the magnitude of reduction in alpha is

modest, our testing shows that it is statistically significant in many cases.

However, both three-factor and five-factor models repeatedly fail the Gibbons,

Ross, and Shanken’s (1989) (GRS) test, suggesting that the quest for a better

asset pricing model is not yet complete.

‘The revolutionary search for a replacement paradigm is driven by the failure of the

existing paradigm to solve certain important anomalies. Any replacement paradigm

had better solve the majority of those puzzles, or it will not be worth adopting in place

of the existing paradigm.’–Bird (2013) on the philosophical concept of Thomas

Kuhn’s paradigm.

I. INTRODUCTION

Over the last half century, the asset pricing literature has progressed in a manner

reminiscent of Kuhn’s (1970) philosophy of science. While the risk–return

relation proposed by the capital asset pricing model of Sharpe (1964) and Lintner

(1965) remains a staple of finance texts, its inability to explain prominent

empirical regularities led to the development of the Fama and French (1993)

* I thank Ramazan Gencay (the Editor), an anonymous referee, Daniel Chai and Phil Ghaghori for

insightful comments. I am especially grateful to Phil Gray for reading all the drafts and giving

suggestions that substantially improve this paper. All remaining errors are my own.

© 2017 International Review of Finance Ltd. 2017

International Review of Finance, 2017

DOI: 10.1111/irfi.12125

International Review of Finance, 18:1, 2018: pp. 123–135

DOI:10.1111/irfi .12125

© 2017 International Review of Finance Ltd. 2017