A Three-Factor Model and Excess Return in an Emerging Market:A Case Study of Listed Companies on Tehran Stock Exchange (TSE)

The primary function of an efficient and deep capital market is to provide a context for supply of highquality and transparent information and to create reasonable liquidity by eliminating information asymmetry, minimising transaction costs, and speeding up transactions. In this research, a three-factor model is proposed based on which the effect (the explanatory power) of three variables market risk (beta), disclosed accounting information quality, and stock liquidity on stock return is investigated. Using time series method, the financial information of 72 TSE-listed companies over a 7-year period (2007-2013) was examined. The stock excess return was found to be significantly associated with market excess return, stock liquidity and accounting information quality. The results, in addition, indicated higher explanatory power of the 3-factor model (beta, information quality, and liquidity) relative to the CAPM single-factor model and the 2-factor model (considering beta and liquidity) in predicting the excess return on TSE.