Risk analysis of Spanish companies
| Published date | 01 March 2024 |
| Author | Juan Antonio Rodríguez‐Sanz,Eleuterio Vallelado,Miguel Fernández‐Martín |
| Date | 01 March 2024 |
| DOI | http://doi.org/10.1111/1758-5899.13316 |
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Global Policy. 2024;15(Suppl. 1):76–91.wileyonlinelibrary.com/journal/gpol
1 | INTRODUCTION
Our study examines the relationship between a com pa-
ny's different types of risk and the informatio n contained
in its financial statements. We identify the determinant s
of the main types of risk in the company and how a
company's financial decision af fect the risk perceived
by the markets, using the traditional three- factor model
by Fama and French(1993). We measure total risk, di-
versifiable risk, market risk, size risk, and value risk.
We decompose systematic or non- diversifiable risk into
market risk, size risk, and value risk.
Traditional valuation models are based on the mean
variance preferences and diversification conc ept devel-
oped in the original proposal of Markowitz's Portfolio
Theory(1952). It was Sharpe(1964), Lintner(1965) and
Mossin (1966) who developed a simplified empirical
estimation of Markowitz's model, which led to the for-
mulation of the Capital Asset Pricing Model (CAPM).
The CAPM is a single- factor model that explains the
return on securities by the market return differential to
the return on risk- free assets, stating that the returns on
an asset are proportional to the returns on the market
portfolio, with β being the factor that measures th is pro-
portionality. However, Alquist etal.(2020) argued that
the CAPM is dead. As an improvement on single- factor
models, Fama and French developed the so- called
three- factor model in 1993 (Fama & French,19 93).1
This model identifies three non- diversifiable risk fac-
tors: the market risk already reflected in the CAPM
proposal, size risk, and value risk. The factors in the
Fama and French model efficiently capture the effect
of a set of variables which, in addition to being highly
predictive of stock price evolution, faithfully reflect the
policies and decisions adopted by companies and that
constitute the essence of their fundamental risk (Li &
Dempsey,2018).
A later version by these authors (Fama &
Frenc h, 2015) proposes an augmented version
that adds two more factors as components of non-
diversifiable risk: profitability and investment. Models
have been developed which have added factors to the
original three- factor model in order to study a wide
range of financial asset price anomalies (Soebhag
RESEARCH ARTICLE
Risk analysis of Spanish companies
Juan AntonioRodríguez- Sanz1 | EleuterioVallelado2 | MiguelFernández- Martín1
Received: 22 Nove mber 2023
|
Ac cepted: 27 November 2023
DO I: 10 .1111/17 58- 589 9.13 316
This is an open ac cess article under t he terms of the Creative Commons Attribution-NonCommercial-NoDerivs License, which perm its use and distributi on in
any medium, provi ded the original work is p roperly cited, the use i s non-commercial a nd no modifications o r adaptations are made.
© 2024 The Authors. G lobal Policy publis hed by Durham Universit y and John Wiley & Sons Ltd.
1Economics and Business School,
Universidad de Vall adolid, Valladolid,
Spain
2Department o f Financial Economic s and
Accounting, Economics and Business
School, Univer sidad de Valladolid,
Valladolid, Spain
Correspondence
Eleuterio Vallelad o, Department of
Financial Economics and Accounting,
Economics and Business School,
Universidad de Vall adolid, Avenida Valle
del Esgueva, 6, 47011 Valladolid, Spa in.
Email: evallelado@uva.es
Funding information
Ministerio de C iencia e Innovación, Gra nt/
Award Number: PID2020- 114797GB- I00
Abstract
This paper aims to investigate the determinants of different types of market risk
faced by Spanish firms from 2012 to 2019. Using Fama and French's (Journal
of Financial Economics, 1993, 33, 3) three- factor model, we estimate total risk,
diversifiable risk, and systematic or non- diversifiable risk in the three dimen-
sions proposed by these authors: market risk, size risk, and valuation risk. Risk
determinants are derived from a series of economic and financial variables ob-
tained from the information contained in financial statements. This information
is summarised using a factor analysis that aims to resolve the correlation issues
between the proposed measures. The study demonstrates that the systematic
risk factors proposed by Fama and French in their 1993 three- factor model in-
corporate dimensions of systematic risk that are relevant to investors and that
the set of economic and financial variables proposed can explain these risks.
Among these variables, profitability and the market to book ratio have the great-
est impact in explaining company risk, while factors such as operating and fi-
nancial leverage, growth, or company insolvency have a much smaller effect as
explanatory factors for risk.
|
77
RISK ANALYSIS
et al., 2022), in what is known as the “factor zoo”
(Cochrane,2 011). Increasing the number of divisions
in systematic risk would mean that a correct interpre-
tation in economic terms proves difficult. As a result,
we focus on the market, size, and value factors as the
most relevant in the literature.
Bali (2008) establishes that the risk premium associ-
ated with beta (market factor) is both pertinent and sta-
tistically significant. Additionally, González- Urteaga and
Rubio(2016 , 2021, 2022) corroborate the presence of
empirical evidence indicating that exposure to the mar-
ket volatility risk premium constitutes a key determinant
of volatility risk premia. Market risk quantifies the vola-
tility stemming from fluctuations in commodity prices,
exchange rates, interest rates, and other factors, which
investors cannot mitigate even through a perfectly di-
versified investment portfolio. In the context of Spain,2
the research by Menéndez- Plans etal.(2012) furnishes
empirical support for the relevance of accounting and
macroeconomic measures in explaining market risk.
For an international sample, León et al. (2007) esti-
mate the coefficient of risk aversion when studying the
intertemporal relationship between risk and expected
return.
Asness et al. (2020) argue convincingly that a
size factor can be highly informative for gaining in-
sights into investor behaviour. Size risk – which is
non- diversifiable – emerges from the variations in
company sizes. This risk primarily arises due to the
greater operational and financial risks typically asso-
ciated with smaller firms, leading them to earn higher
returns compared to their larger counterparts (Fama
& French,2015). Alquist etal.(2018) shed light on the
idea that as long as size remains correlated with a fun-
damental source of risk, rational investors should be
compensated for holding assets that exhibit greater
exposure to this risk. In essence, size risk encapsu-
lates a portion of a broader effect that can enhance
value when considered alongside other risk factors.
These authors provide evidence that the inclusion of
the Fama and French factors significantly strength-
ens the impact of size risk. Consequently, if the aim
is to comprehend investor behaviour, then incorpo-
rating a size factor proves to be highly beneficial. In
conclusion, smaller firms respond differently to var-
ious phases of the business cycle when compared
to their larger counterparts (Amel- Zadeh,2011). This
justification underscores the importance of including
a factor that captures the distinct characteristics of
smaller firms.
González- Sánchez et al. (2018, 2020) convincingly
established that the value factor possesses robust eco-
nomic foundations due to its association with uncer-
tainty and risk aversion. Value risk arises from distinct
corporate strategies: value- oriented versus growth-
oriented. Value companies typically exhibit high book to
market ratios (indicative of high value), whereas growth
companies tend to have low book to market ratios (indic-
ative of low value). Given the lower market valuation, it is
common for markets to undervalue companie s with high
book to market ratios, in anticipation that these com-
panies may subsequently improve their prices and de-
liver superior performance (Fama & French,2006; Li &
Dempsey,2018). Consequently, the market tends to un-
dervalue stocks with high book to market ratios, a metr ic
linked to indicators such as earnings over price, cash
flow over price, or sales over price. These indicators re-
flect an inherent undervaluation of these shares, poten-
tially leading to positive abnormal returns in the future.
Although the study of accounting measures as
determinants of firm risk receives little attention in
contemporary finance research, the tradition has per-
sisted in strategic management literature (Campbell
et al., 2010). Chiou and Su (2007) compile the dual
theoretical and empirical strands that have traditionally
considered the determinants of risk in finance litera-
ture and which consider that the internal determinants
of systematic risk are articulated around the degree of
operating leverage and financial leverage – based on
Hamada(1969, 19 72). Analysis of these two major fac-
tors and their interaction suggests the emergence of
certain other determinants, including earnings, sales,
asset value, and dividend payout.
Campbell etal.(2010) analyse the determinants of
stock performance and systematic risk by focusing on
value and growth stocks. They conclude that th e funda-
mentals related to the evolution of corporate cash flows
are basic determinants of this dimension of non- diver-
sifiable risk highlighted by Fama and French(1993) and
mention classic variables such as volatility, profitability,
and indebtedness. Fama and French (2000) link the
risk associated with the book to market (BTM) factor to
two basic concepts: earnings and financial insolvency.
From a more traditional perspective, Lee and
Hooy(2012) attempt to analyse the systematic risk of
air transport companies in dif ferent areas of the world,
estimating an Intertemporal Asset Pricing Model (IAPM)
Policy Implications
• Any policy that favours higher growth oppor-
tunities will be associated with higher market
risk.
• As companies inc rease their profitability, they
increase their risk.
• Changes in operating and financial leverage
are less relevant than growth opportunities in
companies’ risk.
• Policies that favour gains in solvency do not
reduce substantially the company's market
risk.
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