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Equilibrium Cross-Section of Returns

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  • Gomes, Joao F
  • Kogan, Leonid
  • Zhang, Lu

Abstract

We explicitly link expected stock returns to firm characteristics such as firm size and book-to-market ratio in a dynamic general equilibrium production economy. Despite the fact that stock returns in the model are characterized by an intertemporal CAPM with the market portfolio as the only factor, size and book-to-market play separate roles in describing the cross-section of returns. These firm characteristics appear to predict stock returns because they are correlated with the true conditional market ß of returns. These cross-sectional relations can subsist after one controls for a typical empirical estimate of market ß This lends support to the view that the documented ability of size and book-to-market to explain the cross-section of stock returns is not necessarily inconsistent with a single-factor conditional CAPM model.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3482.

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Date of creation: Aug 2002
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Handle: RePEc:cpr:ceprdp:3482

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Keywords: beta; size and book-to-market factors; business cycle properties of stock returns; CAPM; production based asset pricing;

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