ATJ Asian Tax Journal

Asian Tax Journal

Print ISSN 1738-3323 Online ISSN 2733-9270

The Effect of Gross Profitability on the Expected Stock Return

  • Hyuck Jun Song Duksung Women's University

Asian Tax Journal Vol. 17 No. 1 (2016), pp. 181-197

Abstract

This paper tests the effect of gross profitability on the expected stock return, namely the gross profitability premium in the Korean stock market. The main empirical results are as follows. Firstly, we construct the quintile portfolios in the order of gross profitability and measure the mean return, KOSPI excess return and treasury bond excess return. KOSPI excess return shows monthly －1.43% in the lowest 1st quintile and －0.22% in the highest 5th quintile. KOSPI excess return is strongly monotone increasing from the 1st quintile to the 5th quintile. The gross profitability premium shows 1.22% between the highest 5th quintile and the lowest 1st quintile with the simple mean KOSPI excess return. We think the gross profitability premium is evident in the Korean stock market. Secondly, we construct the double quintile portfolios in the order of both gross profitability and the error term of CAPM model, and measure the mean KOSPI excess return. KOSPI excess return is also monotone increasing from the 1st quintile to the 5th quintile. While the gross profitability premium is biggest in the lowest error term quintile, the gross profitability premium is smallest in the highest error term quintile. But the differences of return are not big throughout the error term quintile portfolios except in the 1st quintile in the lowest gross profitability quintile. It shows the gross profitability premium is robust after we control the market portfolio through the CAPM model. Thirdly, we construct the double quintile portfolios in the order of both gross profitability and the error term of 3 factor model, and measure the mean KOSPI excess return. KOSPI excess return is also monotone increasing from the 1st quintile to the 5th quintile. While the gross profitability premium is biggest in the lowest error term quintile, the gross profitability premium is smallest in the highest error term quintile. But the differences of return are not big throughout the error term quintile portfolios except in the 1st quintile in the lowest gross profitability quintile. It also shows the gross profitability premium is robust after we control the firm－size effect and value effect through the 3 factor model.

Keywords

  • gross profitability
  • gross profit to asset
  • expected stock return
  • premium
  • market anomaly

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