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The Errors in the Variables Problem in the Cross-Section of Expected Stock Returns

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Author Info
 Kim, Dongcheol
Abstract

Recent research has documented the failure of market beta to capture the cross-section of expected returns within the context of a two-pass estimation methodology. However, the two-pass methodology suffers from the errors-in-variables (EIV) problem that could attenuate the apparent significance of market beta. This article provides a new correction for the EIV problem that is robust to conditional heteroscedasticity. After the correction, I find more support for the role of market beta and less support for the role of firm size in explaining the cross-section of expected returns. While the EIV correction leads to a diminished role of firm size, the size variable remains a significant force in explaining the cross-section of expected returns. Copyright 1995 by American Finance Association.

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Article provided by American Finance Association in its journal Journal of Finance.

Volume (Year): 50 (1995)
Issue (Month): 5 (December)
Pages: 1605-34
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Handle: RePEc:bla:jfinan:v:50:y:1995:i:5:p:1605-34

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  1. Wayne E. Ferson & Campbell R. Harvey, 1996. "Fundamental Determinants of National Equity Market Returns: A Perspective on Conditional Asset Pricing," NBER Working Papers 5860, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Wayne E. Ferson & Campbell R. Harvey, 1999. "Conditioning Variables and the Cross-Section of Stock Returns," NBER Working Papers 7009, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Cable, J & Holland, K, 1996. "Modelling Normal Returns in Event Studies: A Model-Selection Approach and Pilot Study," Working Papers 96-13, University of Wales, Aberystwyth, Department of Economics. [Downloadable!]
  4. J. Cable, K. Holland, 1999. "Modelling normal returns in event studies: a model-selection approach and pilot study," European Journal of Finance, Taylor and Francis Journals, vol. 5(4), pages 331-341, December. [Downloadable!] (restricted)
  5. Crama, Y. & Leruth, L. & Renneboog, L.D.R., 1999. "Corporate governance structures, control and performance in European markets : a tale of two systems," Discussion Paper 97, Tilburg University, Center for Economic Research. [Downloadable!]
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  6. Don U.A. Galagedera, 2004. "A survey on risk-return analysis," Finance 0406010, EconWPA. [Downloadable!]
  7. Giuseppe Arbia, 2000. "Estimation Of Market Risk In Case Of Non-Gaussian Asset'S Returns," Departmental Working Papers 133, Tor Vergata University, CEIS. [Downloadable!]
  8. Pierluigi Balduzzi & Cesare Robotti, 2005. "Mimicking portfolios, economic risk premia, and tests of multi-beta models," Working Paper 2005-04, Federal Reserve Bank of Atlanta. [Downloadable!]
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