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Equilibrium Cross Section of Returns

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  • Joao Gomes
  • Leonid Kogan
  • Lu Zhang

Abstract

We construct a dynamic general equilibrium production economy to explicitly link expected stock returns to firm characteristics such as firm size and the book-to-market ratio. Stock returns in the model are completely characterized by a conditional capital asset pricing model (CAPM). Size and book-to-market are correlated with the true conditional market beta and therefore appear to predict stock returns. The cross-sectional relations between firm characteristics and returns can subsist even after one controls for typical empirical estimates of beta. These findings suggest that the empirical success of size and book-to-market can be consistent with a single-factor conditional CAPM model.

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Bibliographic Info

Article provided by University of Chicago Press in its journal Journal of Political Economy.

Volume (Year): 111 (2003)
Issue (Month): 4 (August)
Pages: 693-732

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Handle: RePEc:ucp:jpolec:v:111:y:2003:i:4:p:693-732

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