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The book-to-market equity ratio as a proxy for risk: evidence from Australian markets

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  • Michael Dempsey

    (Department of Accounting and Finance, Faculty of Business and Economics, michael.dempsey@buseco.monash.edu.au)

Abstract

Crucial to the interpretation of the Fama and French three-factor model is the question of whether the book-to-market equity ratio should be assigned as a ‘risk-based,’ as opposed to a ‘mispricing’ explanation of share price formation. In the context of Australian stock markets, we examine the role of the book-to-market equity ratio in the formation of stock returns. Notwithstanding the distinctive characteristics of Australian markets, our findings are complementary with findings for U.S. stocks. We succeed in revealing a strong association between stock returns and the firm’s book-to-market equity ratio, and find strong evidence that the association derives from the book-to-market ratio’s absorption of the implications of market leverage as a risk factor. In addition, we determine evidence of mispricing as contributing to the formation of market leverage itself.

Suggested Citation

  • 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.
    • Handle: RePEc:sae:ausman:v:35:y:2010:i:1:p:7-21
    DOI: 10.1177/0312896209351451
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    References listed on IDEAS

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