A New Measure of Asset Pricing: Friction-Adjusted Three-Factor Model

• Published in: The Journal of Asian finance, economics, and business Vol. 7; no. 12; pp. 605 - 613
• Main Authors: NURHAYATI, Immas, ENDRI, Endri
• Format: Journal Article
• Language: Korean
• Published: 한국유통과학회 30.12.2020; Korea Distribution Science Association
• Subjects: Adjusted Three-Factor; Transaction Cost; Trading Friction; Unfrictionless Markets
• ISSN: 2288-4637; 2288-4645

In unfrictionless markets, one measure of asset pricing is its height of friction. This study develops a three-factor model by loosening the assumptions about stocks without friction, without risk, and perfectly liquid. Friction is used as an indicator of transaction costs to be included in the model as a variable that will reduce individual profits. This approach is used to estimate return, beta and other variable for firms listed on the Indonesian Stock Exchange (IDX). To test the efficacy of friction-adjusted three-factor model, we use intraday data from July 2016 to October 2018. The sample includes all listed firms; intraday data chosen purposively from regular market are sorted by capitalization, which represents each tick size from the biggest to smallest. We run 3,065,835 intraday data of asking price, bid price, and trading price to get proportional quoted half-spread and proportional effective half-spread. We find evidence of adjusted friction on the three-factor model. High/low trading friction will cause a significant/insignificant return difference before and after adjustment. The difference in average beta that reflects market risk is able to explain the existence of trading friction, while the difference between SMB and HML in all observation periods cannot explain returns and the existence of trading friction.