The Predictability of Stock Returns in Taiwan

Abstract

We investigate the cross-sectional predictability of stock returns after controlling for systematic risk factors in Taiwan. We additionally control for GDP growth, industrial production growth and inflation rate because they have a significant and negative pricing premium across stock returns after controlling for market, value and size factors. The negative pricing of GDP growth and Industrial production growth captures the cheap pricing of a stock’s fundamentals because their pricing premiums become insignificant after competing with a stock’s book-to-market ratio, cash-flow yield, earnings yield, dividend yield and leverage yield. The pricing of the inflation factor is negative because a high inflation rate increases the operating costs of corporations and hurts their profitability in Taiwan. We conclude that a stock’s value and cash-flow yield cross-sectionally predict stock returns at 1% level after controlling for market, value and size factors, GDP growth, industrial production growth, and inflation rate.

Keywords: Emerging Market and Return Predictability

JEL Classification: G11, G12, G15