A Factor Model for Country-Level Equity Returns

Abstract

We offer a new three-factor asset-pricing model for country equity returns. The model accommodates a broad set of country-level cross-sectional anomalies better than the popular CAPM, three-factor model, and four-factor model. Furthermore, it fully explains the performance of other models’ factors, while the standard models are not able to explain the alphas of their factors. The new model relies on the country-level portfolios formed based on the EBITDA-to-EV ratio and on skewness-enhanced momentum. These factor portfolios provide reliable and robust sources of return, and their performance is consistent with the behavioral finance mispricing interpretation. This study is based on the accounting and price data from 78 country equity markets in 1995–2015.