INTRODUCTION

Organization behavior is affected by agent biases that ultimately cause return anomalies. A
disagreement arises whether firm asset return predictability caused by mispricing or by risk
premium. Investment decisions of firm are made by managers and pricing decisions made by
investors. Decisions of about productivity of firm are based on information of firm. Agents
decision making choices based on biases produces endogenous relationship in asset return,
investment, valuation, and firm productivity. Managers and investors joint behavior doesnt
observed productivity of firm directly. By this, model doesnt make much richer predictions
of asset return anomalies and firm behavior.
There is a need to measure the risk side as well as behavioural side of firm to make prediction
richer. However, behavioural side can be measured by modelling rational arbitrageurs
whereas; alternative sources of risk can predict return anomalies.

Aims and Objectives

This study aims at:
a) Investigating the rational arbitrageurs performance that apparently affects return
anomalies
b) Alternative sources of risk to predict return anomalies
c) Behavioural side can be measured by modelling rational arbitrageurs
d) Study about how sources of risk effect on return anomalies
e) Which sources of risk is more significant in determining return anomalies
f) Study about rational arbitrageur performances that affect firm return anomalies

BACKGROUND
In order to understand and predict the return anomalies a need rise to estimate the behavioral
and risk side of firm. Area is not much as old as a little work require to pursue it further. On
the risk side, few models have been proposed previously (e.g; Berk et al. (1999), Gomes et
al. (2003), Bansal et al. (2005), and Liu et al. (2009)). In these studies different models have
been applied like dynamic real option model, dynamic equilibrium model, Vector autoregression, and generalized method of moments (GMM) to understand the risk side of firm.
They all explain different parameters of firm in different time frame. Details of these studies
are given below in literature. These studies gave some limitations. In the light of these
limitations, further work need to be done on this area.
On the behaviour side, a need rise to understand the arbitrageur role. As arbitrage industry
works on equity market anomalies including moment and value effects that are continually
growing. Usually arbitrageur draw fund coming from outside. Their value deviation requires
larger funds to do arbitrage activity. Fama, (1965) reported that arbitrage is an activity where
larger no of investors hold position against manipulation of pricing. According to the
researcher, in order to avoid the manipulation of pricing well-informed investors usually hold
large position by utilizing resources.
According to Thaler, (1999) market common anomalies are volume, volatility, cash
dividends, equity premium puzzle, and predictability. Equity hedge funds follow strategy
seeking return from these anomalies. A survey estimates that growth rate exceeds 15% yearly.
This increasing rate is accompanied by increased short-long interest from academics and
practitioners alike. Short-interest analysis is more informative than long-side as long-side
analysis has little and no time to determine variations in arbitrage capital. However, more
work required to analyse the arbitrageurs role in estimating the behaviour side of the firm.

LITERATURE REVIEW
Few studies have been conducted to investigate the firm behavioral and risk-side effect on
returning anomalies. These are given below in chronological order.
Literature review on Risk based explanation of return anomalies
Berk et al. (1999) investigate security return, optimal investment, and growth options by
proposing dynamic model of real option. In the model, growth options are varying and
investment use in place of asset. The model also feature systematic risk and projected cash
flows. From the statistical results, Berk et al. (1999) conclude that growth options changes
gradually and play important role in predicting systematic risk and return. However, gaps
remains unfilled in that firm-level variables beside, exogenous variable of productivity are
determined endogenously even in equilibrium. Therefore, neoclassical model provide more
fundamental explanation of risk, return and firm-level variables.
Gomes et al. (2003) report theoretical explanation of risk and expected return in dynamic
equilibrium model of book-to-market and size. According to the model, investment plans are
independent of firm productivity as they have identical growth options. As firm having
profitable growth pay dividend more than less profitable firm by this, profitable firm cant
invest more. Profitable firm usually generate cash flow in shorter duration than value firm.
From the statistical results, Gomes et al. (2003) conclude that more positive value premium is
produce by profitable firm on the basis of equity duration risk. However, by using equal
growth assumption, firm can allow to settle down investment plans maximally to current
productivity.
Bansal et al. (2005) investigate the cross section of equity returns along with dividends and
consumption. Cash flows having consumption risk across size-sorted portfolios, book-tomarket accounts for a minimum difference in risk premium. Vector auto-regression applies to
test the dynamic model of discounted cash flows growth and beta of consumption. 60%
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variation in risk premium find in these cash flows beta. Significant cash flows risk at market
price find. From the statistical results, Bansal et al. (2005) conclude that cash flow risk is
acting as an important factor in interpreting the divergence in risk compensations.
Liu et al. (2009) investigate stock returns based on investment by applying generalized
method of moments (GMM). The GMM model is cost conscious as having two parameters.
They use first and second moment condition empirically that are based on q-theory. When
match the moments, the volatility become reasonable. From the statistical results, Liu et al.
(2009) conclude that only a portfolio of firms can match their cost of capital with the
investment policy. However, as they do not take the discount factor, the work is not much
significant as a gap remains that why return spreads not match with covariance empirically.
Literature review on behavioural side to determine return anomalies
Lo, (2004), and Stein, (2009) reporting that minor limitations against arbitrage cause a rapid
growth in arbitrage capital in order to remove return anomalies. A gap remains as if frictions
of limitations against arbitrage are severe than anomaly cant be remove in long-run
condition. By this, capital arbitrage becomes crucial at strategy-level

Hirshleifer et al. (2011) explain theoretically that short- interest investors can easily remove
the anomaly like value signals and book-to-market e.t.c. Studies of Brunnermeier and
Pedersen, (2009), and Brunnermeier and Sannikov, (2012) reported that increase in asset
price volatility lead to reduce funding constraints.METHODOLOGY
Research Questions
R1: Do alternative sources of risk have same effect on return anomalies?
R2: Which sources of risk is more significant in determining return anomalies?
R2: How rational arbitrageur performances affect firm return anomalies?
Research Design
The study is conducted to investigate affect of rational arbitrageur and alternative sources of
risk on return anomalies. Research will be of experimental/empirical nature.
Data Collection
For this purpose, secondary data will be used. Data will be collected from period 2000 to
2014. Data will be collected from websites as well as from financial reports of companies
including public limited and private limited.
Measurement
1. For measuring behaviour of firm, rational arbitrageur performance will be analyzed
in the form of taking book-to-market value of firm, predictability, volatility, volume,
cash dividends, and equity premium puzzle.
2. For measuring risk side of firm, alternative models like dynamic real option model,
dynamic equilibrium model, vector auto-regression, and generalized method of
moments (GMM) will be used. These models will be computed, compared in order to
get clear justification of the phenomena.

Analysis Methodology
Regression Analysis
This study describes the application of regression analysis for obtaining a two - dimensional
areal description of heterogeneous reservoirs from short-term pressure-time data such as that
obtained in interference tests. The method replaces the time-consuming trial-and-error
procedure.
It is divided into a number of homogeneous blocks whose transmissibility (kh/f) and storage
(fch) values are varied to obtain the least-squares fit. The reliability of these values is
determined from their standard deviations and correlation coefficients.
The method is rigorously applicable to single-phase flow only, multiphase flow can be
handled provided saturation changes are small during the test. Possibly the method can also
be used to obtain a reservoir description from pressure-production history, but this application
is outside the scope of this work.
The study includes, in addition to a description of the numerical procedure, a discussion of
some of the problems associated with the method. Rules are given to help in selecting the
number of homogeneous blocks and deciding upon their arrangement
Pressure data from short-term transient tests, such as single-well and interference tests, are
widely used to obtain reservoir properties. These tests are usually analyzed by assuming a
simple reservoir model; very often, a homogeneous one is used. As a result, analysis of the
transient data from each well frequently gives different values for reservoir properties. The
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problem then arises to combine all these differing results into a more detailed picture of the
reservoir. While the analysis presented in this study applies the same general principle used
by Jacquard and Jain, the specific method is significantly different.

Models
For Rational Arbitrageur

Y = + 1X1 + 2X2 + 3X3 + 4X4 +5X5 + t .(3.1)

Where, Y is Return Anomalies, X1 is value of firm, X2 is predictability, X3 is volatility, X4
is volume, X4 is cash dividends, and X5 is equity premium puzzle, and are
coefficients, and is error term.
For risk side
Vector auto-regressive model

yt = c + A1yt-1 + A2yt-p + et,(3.2.1)

Where, ytl is called the l-th lag of y, c is a k 1 vector of constants. Aiis a time-invariant
matrix and et is error terms.
Generalized Method of Moments
= argmin (

1/T Tt=1 g ( Yt , )) W ( 1/T Tt=1 g ( Yt , )).(3.2.2)

Where, W is a positive-definite weighting matrix, and m denotes transposition. In practice,

the weighting matrix Wis computed based on the available data set, which will be denoted
as

Dynamic equilibrium model of book-to-market and size

Y = + X + t .(3.2.3)
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Where, Y is firm productivity, X is investment plans, and are coefficients, is error term.

Bibiolgraphy
Bansal, R., Dittmar, F. R., and Lundblad, T. C. 2005. Consumption, Dividend, and the Cross
Section of Equity Returns. Journal of Finance , 60, 1639-1672.
Berk, J. B., Richard, C. G., and Naik, V. 1999. Optimal Investment, Growth Options, and
Security Returns. Journal of Finance , 54, 1533-1607.
Brunnermeier, M., and L. Pedersen. 2009. Market Liquidity and Funding Liquidity. Review
of Financial Studies, 22, 220138.
Brunnermeier, M., and Y. Sannikov. 2012. A Macroeconomic Model with a Financial Sector.
Working Paper, Princeton University.
Fama, E. 1965. The Behavior of Stock-Market Prices. The Journal of Business, 38, 34-105.
Gomes, J., Leonid, K., and Lu, Z. 2003. Equilibrium Cross Section of Returns. Journal of
political economy , 111, 693-732
Hirshleifer, D., S. Teoh, and J. Yu. 2011. Short Arbitrage, Return Asymmetry and the Accrual
Anomaly. Review of Financial Studies, 24, 242961.
Liu, L., Whited, M. T., and Lu, Z. 2009. Investment based Expexted Stock Returns. Journal
of Political Economy , 117, 1105-1139.
Lo, A. 2004. The Adaptive Markets Hypothesis: Market Efficiency from an evolutionary
perspective. Journal of Portfolio Management, 30, 1529.
Stein, J. 2009. Presidential address: Sophisticated Investors and Market Efficiency. Journal
of Finance, 64, 151748.
Thaler, R. 1999. The end of Behavioural Finance. Financial Analysts Journal, 55, 12-17.