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Abstract

This paper explains the size and value “anomalies†in stock returns using an economically motivated two-beta model. We break the beta of a stock with the market portfolio into two components, one reflecting news about the market’s future cash flows and one reflecting news about the market’s discount rates. Intertemporal asset pricing theory suggests that the former should have a higher price of risk; thus beta, like cholesterol, comes in “bad†and “good†varieties. Empirically, we find that value stocks and small stocks have considerably higher cash-flow betas than growth stocks and large stocks, and this can explain their higher average returns. The post- 1963 negative CAPM alphas of growth stocks are explained by the fact that their betas are predominantly of the good variety.

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Paper provided by Harvard - Institute of Economic Research in its series Harvard Institute of Economic Research Working Papers with number 1971.

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Date of creation: 2002
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Handle: RePEc:fth:harver:1971

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• G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
• G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies

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