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Censoring, Firm Size and Trading Volume on Beta Risk Estimation of Malaysian BankingStocksAssoc Prof Dr Norashfah Hanim Yaakop Yahaya Al-Haj
ABSTRACT
This paper examines the impact of censoring, firm size and trading volume on beta risk estimations of Malaysian banking stocks. An alternative beta risk estimator is used to copewith a situation of extreme thin trading, those with frequent zero observations in their return series. The study illustrates the empirical behavior of Malaysian banking stocks from the period 1998 to the year 2000 via the basic approach in the context of a sample selectivitymodel. Particularly, the model separates two components which comprise a selectivityequation that deals with the “spike” and a regression model that is applied to the non-censored data.
 
The preliminary judgement as such that Malaysian banking stocks may beassociated with thin trading, the results should give some downward bias and the use of a standard estimator will understate expected returns. The results of the study here, seems mixed  giving some lower and some higher estimates. Even though that, the changes in the different estimations are still minimal. It is plausible to see such a result as the banking sector is a largebusiness sector in the economy.
Keywords: Malaysian Banking Stocks, Beta Risk Estimation, Firm Size, Trading Volume,Censoring and Thin Trading.
1. ITRODUCTIO
In addressing global economic challenges, Malaysia has participated actively in international path tomaintain the momentum for reform and offered outstanding consideration of the diverse backgroundof countries in the global system. As it is envisaged that the financial sector will not only play a moreefficient and significant role in supporting the continued transformation process in the economy, butalso become an important source of growth in the economy. The financial system comprises of threedifferent parts that are the banking system, the non-bank financial intermediaries and the financialmarkets. So far, the structure of the financial system in Malaysia is well diversified and this is thedirect result of the authorities’ steady effort to liberalise and develop the financial market. Nonetheless, the global economic and business environment as well as rapid technological advancesover the last decade has had a significant impact on the development of the financial system of Malaysia. However, the country’s policies for expansion and diversification started later than inEurope and the US thus, not surprisingly, the depth of the market is undersized relative to the westernregion. In addition, the stocks in the market will also be mostly thinly traded
1
. Ibbotson, Kaplan andPeterson (1997) and Annin (1997) state that thin trading is strongly associated with firm size,meaning the most thinly traded stocks are the smallest stocks. Further, it is most likely that thesesmallest stocks exhibit severe problems with their beta risk estimates. Due to this fact, in terms of coping with the technique of beta estimation, the risk assessment procedures have to suit situations of thin trading to avoid incorrectly estimated betas.
1
It is well known in the literature that thin trading and firm size are strongly related, example Roll (1981) and Reinganum (1982)
 
 It cannot be denied that systematic risk or the beta measurement is central to many applications of finance
2
. The common technique to estimate beta is to apply the standard empirical testing of theCapital Asset Pricing Model (CAPM). The model was originally proposed, by Sharpe (1964) andLintner (1965). The CAPM predicts that the expected return on an asset above the risk free rate is proportional to non-diversifiable risk, which is measured by the covariance of the asset return with thereturn in the market portfolio. In the CAPM, there should be a positive and linear relationship between expected return and systematic (beta) risk. The main concern of this standard model is that itassumes beta is constant. This in itself caused the main problem in the empirical implementation of the CAPM and researchers face a multitude of choices in beta estimations
3
.The issue of beta estimation gets more involved when dealing with thinly traded stocks. And mostlikely, this will induce a bias in the estimated betas. Significant progresses has been made along thelines of providing alternative beta estimators to overcome these thin trading problems, and wereillustrated in the work of Scholes and Williams (1977), Dimson (1979) and Fowler and Rorke (1983).However, it is likely that none of these alternative estimators will perform well in cases of extremethin trading because in extreme circumstances, the stock will not be traded at all for a given periodhence, resulting in an observed zero change in price and consequently, zero return. As such, in thesecases, using the standard market model estimated under the ordinary least squares estimators wouldnot have the desirable statistical properties of consistency, unbiasedness and efficiency
4
. Thus, what isdesired is a configuration that separates the modeling of the zero return observations from the non-zero return observations.The study of Reinganum (1982) suggests an adjustment to beta estimates to correct for the thintrading bias but does not produce betas that are large enough to explain the ‘small firm’ effect. This isthe motivation of the present study to provide better estimates of the betas of the Malaysian bankingstocks that are most likely to be smaller than their western counterparts. Hence, the fundamental purpose here is to adapt the technique by Brooks et al. (2004) designed for coping with the situationof extreme thin trading
5
. Further, in providing greater scope to the study, the superiority of the modelwill also be compared to the most commonly used technique of thin trading; that is the Dimsonestimator with two leads and two lags of the market return. Specifically, this study will utilize thetechnique that adjusts for the censoring induced in the data that is, the “spike” of zero returns thatoccurs for stocks subject to extreme cases of thin trading. In addition to its simplicity, the model isknown to have desirable statistical properties as it is done in a two-stage process, explained in asample selectivity model. This model is exemplified by a selectivity equation that deals with the“spike” and a regression model that is applied to the non-censored data. Hence, we describe theresultant beta estimates as selectivity corrected betas.The plan of the paper is as follows. Section 2 and 3 of the paper will go over respectively, the background of the study which includes the literature review and research methodology of the study.Section 4 summarizes the research findings and presents the data analyzed and the results. Section 5contains some concluding remarks.The next section confers the literatures on risk dynamism in the Malaysian banks with utilisation of econometric modelling in regards to censoring, size and volume of Malaysian Banking Stock.
2
Systematic risk is the portion of risk that cannot be diversified away and is held by investors.
3
See the work of Brailsford, Faff and Oliver (1997)4 The result will be statistically tested, later in the paper.5 See also the work of Lange (1999) on modeling asset market volatility in a small market.
 
 
2.0 LITERATURE REVIEW2.1 Trading Volume and Firm Size
The global economic and business environment as well as rapid technological advances over the last decade has had a significant impact on the development of the financial system of Malaysia. However, the country’s policies for expansion and diversification started later thanin Europe and the US. Not surprisingly, the depth of the market is small. The stocks in themarket will also be mostly thinly traded
6
. In addition, the fact that the Malaysian market mostcommonly associated with large shareholders and small float this could add to possibility of thin trading. Ibbotson, Kaplan and Peterson (1997) and Annin (1997) stated that thin trading isstrongly associated with firm size, meaning the most thinly traded stocks are the smalleststocks. Further, it is most likely that these smallest stocks exhibit severe problems with their  beta risk estimates. Due to this fact, in terms of coping with the technique of beta estimation,the risk assessment procedures have to suit situations of thin trading to avoid incorrectlyestimated betas.
2.2 Censoring
“Censored data” for an asset is the presence of zero returns in the observed return data. This isthe case when there will be an occurrence of a “spike” in the distribution of returns at zero. Thedegree of censoring in a dataset with
n
observations may be measured by the proportion of observations piled up at the censoring point (in the case here at zero). This proportion is given by
c
=
n
1
/
n
, where
n
1
is the number of observations at the censoring point, zero.As noted in Maddala (1989) and Greene (2003, 1997), the parameters in a linear regressionmodel are biased and inconsistent in the presence of censoring in a variable. The extent of the bias and inconsistency problems in the least squares estimators depends upon the degree of censoring, which is
c
. The closer 
c
is to unity, the more severe are the problems and when
c
 equals zero there is no censoring and least squares estimators are appropriate. It is thecensoring in the dependent variable that causes the problems with the estimation technique.The purpose of this paper is to adapt the technique by Brooks, Faff, Fry, and Gunn, (2004)designed for coping with the situation of extreme thin trading
7
. Further, in providing greater scope to the study, the superiority of the model will also be compared to the most commonlyused technique of thin trading that is the Dimson estimator with two leads and two lags of themarket return.Specifically, this study will utilize the technique that adjusts for the censoring induced in thedata that is, the “spike” of zero returns that occurs for stocks subject to extreme cases of thintrading. In addition to its simplicity, the model is known to have desirable statistical propertiesas it is done in a two-stage process, explained in a sample selectivity model. This model isexemplified by a selectivity equation that deals with the “spike” and a regression model that isapplied to the non-censored data. Hence, we describe the resultant beta estimates as selectivitycorrected betas.
6
It is well known in the literature that thin trading and firm size are strongly related; for example Roll (1981) and Reinganum(1982)
7
See also the work of Lange (1999) on modeling asset market volatility in a small market.
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