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Stock returns, size, and book-to-market equity

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  • Pradosh Simlai
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    Abstract

    Purpose – The purpose of this paper is to reinvestigate the performance of common stock returns with respect to two popularly known firm level characteristics: size and book-to-market ratio. Design/methodology/approach – All of New York Stock Exchange, American Stock Exchange, and National Association of Securities Dealers Automated Quotations stocks between July 1926 and June 2007 are used, and divided into various size and book-to-market equity groups. The extension of the various versions of the simple Fama-French model is implemented. Findings – From the findings, it is inferred that: two risk factors based on the mimicking return for the size and book-to-market ratio play a significant role in capturing strong variation in stock returns; and volatility persistence can significantly improve the common risk factors' impact in explaining the time series variation in size and book-to-market sorted portfolios. Research limitations/implications – In some sense, the model is based on only two firm level variables. In reality there exists plenty of other sources of average return anomalies. For a clearer understanding, an integration of various firm level characteristics would be an interesting issue to explore. A general equilibrium model that incorporates volatility exposure in a Fama-French framework would be a challenging task as well. Practical implications – The approach will help scholars and investment professionals make robust quantification of risk and average returns with respect to various measures of fundamental value. Originality/value – The patterns in the monthly and yearly average excess returns with respect to two firm level characteristics, which documented are consistent with earlier studies. Even though the important role of firm level characteristics on the average-return anomalies of common stocks is widely known, the approach is the very first that extends its support with respect to volatility models.

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    Bibliographic Info

    Article provided by Emerald Group Publishing in its journal Studies in Economics and Finance.

    Volume (Year): 26 (2009)
    Issue (Month): 3 (August)
    Pages: 198-212

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    Handle: RePEc:eme:sefpps:v:26:y:2009:i:3:p:198-212

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    Web page: http://www.emeraldinsight.com

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    Related research

    Keywords: Financial risk; Stock returns; Volatility;

    References

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September.
    2. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, 09.
    3. Fama, Eugene F. & French, Kenneth R., 1997. "Industry costs of equity," Journal of Financial Economics, Elsevier, vol. 43(2), pages 153-193, February.
    4. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    5. Shanken, Jay, 1990. "Intertemporal asset pricing : An Empirical Investigation," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 99-120.
    6. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-65, June.
    7. Banz, Rolf W., 1981. "The relationship between return and market value of common stocks," Journal of Financial Economics, Elsevier, vol. 9(1), pages 3-18, March.
    8. Tarun Chordia, 2001. "Market Liquidity and Trading Activity," Journal of Finance, American Finance Association, vol. 56(2), pages 501-530, 04.
    9. Black, Fischer, 1972. "Capital Market Equilibrium with Restricted Borrowing," The Journal of Business, University of Chicago Press, vol. 45(3), pages 444-55, July.
    10. Robert C. Merton, 1980. "On Estimating the Expected Return on the Market: An Exploratory Investigation," NBER Working Papers 0444, National Bureau of Economic Research, Inc.
    11. Chou, Ray Yeutien, 1988. "Volatility Persistence and Stock Valuations: Some Empirical Evidence Using Garch," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 3(4), pages 279-94, October-D.
    12. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    13. Chan, Louis K C & Hamao, Yasushi & Lakonishok, Josef, 1991. " Fundamentals and Stock Returns in Japan," Journal of Finance, American Finance Association, vol. 46(5), pages 1739-64, December.
    14. De Bondt, Werner F M & Thaler, Richard, 1985. " Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
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    Cited by:
    1. ALAM Nafis & TAN Ee Chain, 2012. "Impact Of Financial Crisis On Stock Returns: Evidence From Singapore," Studies in Business and Economics, Lucian Blaga University of Sibiu, Faculty of Economic Sciences, vol. 7(2), pages 5-19, August.

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