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The dual index model - Empirical proof of an astute model that augurs stock prices across assorted sectors

S, Suresh Kumar and V, Joseph James and S R, Shehnaz (2017): The dual index model - Empirical proof of an astute model that augurs stock prices across assorted sectors. Published in: GLOBAL BUSINESS & ECONOMICS ANTHOLOGY , Vol. 1, No. 2017 (March 2017): pp. 13-26.

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Abstract

The power of Sectoral indices computed and published by stock exchanges, in pricing of asset had been overlooked and existing literature on sectoral indices had been limited to influence of macroeconomic factors on them. The Single index Model (1964) postulates the market index to represent all the macroeconomic uncertainties. The Fama and French Three Factor Model (1993) is an asset pricing model that expands on the Capital Asset Pricing Model (CAPM) by adding size and value factors to the market risk factor in CAPM. With single index model and multi factor model at the two extremes, an intermediate model, that augments the technicals of a stock to its fundamentals, is the critical idea postulated here, to predict future prices. The model referred to Dual Index Model, empirically tests the security returns of all thirty securities that are constituents of India’s premier stock exchange index, i.e. The Bombay Stock Exchange’ (BSE) BSE- Sensex and its Sectoral Indices. The multiple regression model developed augments technical analysis to fundamentals of a stock by incorporating company, industry and economy factors as intercept and slopes by assuming that industry factors are represented by excess returns on sectoral indices while economy factors are reflected in excess returns of general market index. The validated multiple regression models either Ordinary least squares or Auto Regressive Conditional Heteroskedasticty, has been used to forecast returns and predict prices of an out of sample period that follows the sample period. The experimental result on predictive potential of the postulated model is a conclusive evidence of high degree of precision in forecast. The use of multi variate analysis with the postulated model can be effectively applied on any securities listed in the stock exchange irrespective of the fact whether it is included in computation of market index or not.

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