A study on the relationship between arbitrage risk and stock mispricing in the Philippine stock market in the years 2007 to 2014

• Main Authors: Barug, Alana Kirsty D., Santos, Ivy Jean Christy T.
• Format: text
• Language: English
• Published: Animo Repository 2016
• Subjects: Stocks—Prices—Philippines; Arbitrage—Philippines; Finance
• Online Access: https://animorepository.dlsu.edu.ph/etd_bachelors/5488; https://animorepository.dlsu.edu.ph/context/etd_bachelors/article/6107/viewcontent/Barug_and_Santos_2016b.pdf
• Institution: De La Salle University

The proponents of the paper investigate the existence of stock mispricing in the Philippine stock market, examine its relation to arbitrage risk, and explore its practical implications regarding investment portfolio construction. Two mispricing measures are constructed to measure price deviations: first is based on relative valuation and excess valuation second is based on residual income valuation. After establishing the presence of mispricing, multiple regression tests are conducted to see the relationship between mispricing and arbitrage risk. More than the market factor (beta) from the capital asset pricing model (CAPM), the application of the Fama-French 3-factor and 4-factor model allowed for other stock return determinants to be taken into account specifically size, value and momentum.Through univariate test, findings demonstrated the existence of price deviations in the market. Mutlivariate results, on the other hand, showed the direct relationship between arbitrage risk and stock mispricing. it was also proven that the book-to-market (BM) ratio is a weaker indicator of mispricing - which is consistent with the results of Doukas, Kim and Pantzalis (2010), and is contradictory with the results of Ali, Hwang and Trombley (2003). Furthermore, a different multiple regression test on the Fama-French models indicated that, excluding the factor of size, the variables of market, value and momentum are all statistically significant at conventional levels-- indicating that they are stock returns determinants. Summarily, these results imply that greater mispriced stocks exhibit higher arbitrage risk and therefore, have higher excess returns and hence, in line with the theory that the existence of mispricing is brought by the failure of investors to hedge arbitrage risk, particularly idiosyncratic risk. Therefore, with premium as compensation, the found relationship between stock return and arbitrage risk provides another practical avenue for practitioners to engineer and monitor their investment portfolios.