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The Fama‐French Model, Leverage, And The Modigliani‐Miller Propositions

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  • Martin Lally

Abstract

For a cost‐of‐equity model to conform to the Modigliani‐Miller cost‐of‐capital propositions, any sensitivity coefficients in the model must be related to the firm's leverage. In this paper I apply these principles to the Fama‐French model for the cost of equity and develop the relation between its sensitivity coefficients and firm leverage. I then examine an empirical process developed by Fama and French (1997) to model the evolution through time of their sensitivity coefficients and show that this empirical process is inconsistent with the Modigliani‐Miller propositions. Separable functions are proposed for these sensitivity coefficients that are consistent with the Modigliani‐Miller propositions.

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  • Martin Lally, 2004. "The Fama‐French Model, Leverage, And The Modigliani‐Miller Propositions," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 27(3), pages 341-349, September.
    • Handle: RePEc:bla:jfnres:v:27:y:2004:i:3:p:341-349
    DOI: 10.1111/j.1475-6803.2004.00098.x
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    Cited by:

    1. Michael Dempsey, 2015. "Stock Markets, Investments and Corporate Behavior:A Conceptual Framework of Understanding," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number p1007, December.
    2. Michael Dempsey, 2010. "The book-to-market equity ratio as a proxy for risk: evidence from Australian markets," Australian Journal of Management, Australian School of Business, vol. 35(1), pages 7-21, April.

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