Optimal Investment, Growth Options, and Security Returns

As a consequence of optimal investment choices, a firm's assets and growth options change in predictable ways. Using a dynamic model, we show that this imparts predictability to changes in a firm's systematic risk, and its expected return. Simulations show that the model simultaneously reproduces: (i) the time-series relation between the book-to-market ratio and asset returns; (ii) the cross-sectional relation between book-to-market, market value, and return; (iii) contrarian effects at short horizons; (iv) momentum effects at longer horizons; and (v) the inverse relation between interest rates and the market risk premium.     

Relations Between Stock Returns and Fundamental Variables: Evidence from a Segmented Market

This study examines relations between stock returns and potential explanatory factors in Korea, an important and segmented emerging market. Our results show that Korean stock returns in general and returns on stocks listed in Section 1 in particular are significantly positively related to book-to-market, sales-price, and debt-equity ratios, but not significantly related to market value of equity. Returns on stocks listed in Section 2 are, however, negatively related to market value of equity and not significantly related to the other three variables. Among the variables investigated by us, book-to-market ratio has the greatest explanatory power for stock returns and it indicates superior returns for value stocks. Our findings strengthen the international evidence of the role of book-to-market ratio in explaining stock returns by demonstrating its significance even in the segmented Korean market.     

Size,value and momentum in stock returns: evidence from India

This paper examines the effects of size, value and momentum on the cross-sectional relation between expected returns and risk in the Indian stock market. We find that the conditional Carhart four-factor model empirically describes the variation of cross-section of return better than the unconditional model. When size, book-to-market and momentum effects are controlled in the conditional model, the positive relation of market beta, book-to-market and momentum with expected returns remains economically and statistically significant. However, this evidence is found to be subject to characteristics of test portfolios. The expected returns are sensitive to changes in predictive macroeconomic variables.     

SMALL FIRM AND VALUE EFFECTS IN THE CANADIAN STOCK MARKET

We examine the relation among average returns, market beta, firm size, and book-to-market value for Canadian stocks during 1975–92. We document a negative relation between average return and the market capitalization of firms, but find no relation between average return and market beta. While the small firm effect is significant during a period of reduced capital gains tax, it is noticeably lower than during the period leading up to the change. We find that average returns are positively related to book-to-market value especially during the period of lower capital gains tax.     

Another Look at the Cross-section of Expected Stock Returns

Our examination of the cross-section of expected returns reveals economically and statistically significant compensation (about 6 to 9 percent per annum) for beta risk when betas are estimated from time-series regressions of annual portfolio returns on the annual return on the equally weighted market index. The relation between book-to-market equity and returns is weaker and less consistent than that in Fama and French (1992). We conjecture that past book-to-market results using COMPUS-TAT data are affected by a selection bias and provide indirect evidence.     

Beta,size, book-to-market equity and returns: A study based on UK data

This paper examines the role of beta, size and book-to-market equity as competing risk measurements in explaining the cross-sectional returns of UK securities for the period July 1980 through June 2000. The methodology of [Fama, E., French, K., 1992. The cross-section of expected stock returns. Journal of Finance 47, 427–467] and [Pettengill, G., Sundaram, S., Mathur, I., 1995. The conditional relation between beta and returns. Journal of Financial and Quantitative Analysis 30, 101–116] is adopted. Results show that, when adopting the methodology of [Pettengill, G., Sundaram, S., Mathur, I., 1995. The conditional relation between beta and returns. Journal of Financial and Quantitative Analysis 30, 101–116], where data is segmented between up and down markets, a significant relationship is found between beta and returns even in the presence of size and book-to-market equity. Size is not found to be a significant risk variable, whereas book-to-market equity is found to be priced by the market and is thus a significant determinant of security returns. This is the case irrespective of the methodology adopted.     

THE EFFECT OF SIZE,BOOK-TO-MARKET EQUITY,PRIOR RETURNS,AND BETA ON STOCK RETURNS: JANUARY VERSUS THE REMAINDER OF THE YEAR

Size and book-to-market equity are shown to transcend beta in explaining stock returns. One possible explanation of the book-to-market equity effect is overreaction. We investigate the effect of size, book-to-market equity, prior returns, and beta on stock returns. We find significant reversals in January consistent with overreaction. We find a strong positive relation between returns and prior returns for February through December. Both patterns are distinct from either a size or book-to-market equity effect. Book-to-market equity is significantly related to returns, with some evidence of a stronger effect in January.     

Book-to-Market Components, Future Security Returns, and Errors in Expected Future Earnings

This study investigates whether the ability of book-to-market to predict returns derives from systematic errors in the market's expectation of future earnings. We extend Beaver and Ryan (1996, 2000) by decomposing book-to-market into a more persistent (bias) component and a delayed recognition (lag) component. We find that both components are related to analyst expectations of future earnings, but the lag component is the dominant factor across all forecast horizons. Similarly, we find that the lag component explains most of the inverse relation between book-to-market and future returns. Given that lag is constructed by regressing book-to-market ratios on lagged price changes, our results are consistent with the lag component capturing systematic stock price reversals. We find that the components have unique relations with subsequent earnings forecast revisions, and controlling for these relations substantially mitigates the components' ability to predict returns. Our component-level analysis provides insight into how expected future earnings, summarized in book-to-market ratios help to explain this market anomaly.     

The relationship between size,book-to-market equity ratio,earnings–price ratio,and return for the Hong Kong stock market

In this paper, we investigate the relation between stock returns and β, size (ME), leverage, book-to-market equity ratio, and earnings–price ratio (E/P) in Hong Kong stock market using the Fama and French (FF) [J. Finance 47 (1992) 427] approach. FF find that two variables, size and book-to-market equity, combine to capture the cross-sectional variation in average stock returns associated with β, size, leverage, book-to-market equity, and E/P ratios. In this paper, similar to previous studies in Hong Kong and US stock markets, we find that β is unable to explain the average monthly returns on stocks continuously listed in Hong Kong Stock Exchange for the period July 1984–June 1997. But three of the variables, size, book-to-market equity, and E/P ratios, seem able to capture the cross-sectional variation in average monthly returns over the period. The other two variables, book leverage and market, are also able to capture the cross-sectional variation in average monthly returns. But their effects seem to be dominated by size, book-to-market equity, and E/P ratios, and considered to be redundant in explaining average returns when size, book-to-market equity, and E/P ratios are also considered. The results are consistent across subperiods, across months, and across size groups. These suggest that the results are not driven by extreme observations or abnormal return behavior in some of the months or by size groups.     

Firm Size,Book-to-Market Ratio,and Security Returns: A Holdout Sample of Financial Firms

Fama and French (1992) document a significant relation between firm size, book-to-market ratios, and security returns for nonfinancial firms. Because of their initial interest in leverage as an explanatory variable for security returns, Fama and French exclude from their analysis financial firms, thus creating a natural holdout sample on which to test the robustness of their results. We document that the relation between firm size, book-to-market ratios, and security returns is similar for financial and nonfinancial firms. In addition, we present evidence that survivorship bias does not significantly affect the estimated size or book-to-market premiums in returns. Our results indicate data-snooping and selection biases do not explain the size and book-to-market patterns in returns.     

The Conditional Beta and the Cross-Section of Expected Returns

We examine the cross-sectional relation between conditional betas and expected stock returns for a sample period of July 1963 to December 2004. Our portfolio-level analyses and the firm-level cross-sectional regressions indicate a positive, significant relation between conditional betas and the cross-section of expected returns. The average return difference between high- and low-beta portfolios ranges between 0.89% and 1.01% per month, depending on the time-varying specification of conditional beta. After controlling for size, book-to-market, liquidity, and momentum, the positive relation between market beta and expected returns remains economically and statistically significant.     

Stock returns and beta,firms size,E/P,CF/P,book-to-market,and sales growth: evidence from Singapore and Malaysia

Using data from Singapore and Malaysia for the period 1988–1996, this paper examines the relationship between stock returns and beta, size, the earnings-to-price ratio, the cash flow-to-price ratio, the book-to-market equity ratio, and sales growth (SG). We find the presence of anomalies in these emerging markets. There is a conditional relationship between beta and stock returns for both countries. During months with positive market excess returns, there is a significant positive relationship. We also find a negative relationship between beta and stock returns during months with negative market excess returns. We document the existence of a negative relationship between stock returns and size for both countries. For Singapore, we also document a negative relationship between returns and SG. For Malaysia, we find a positive relationship between returns and the E/P ratio. These relationships are only significant in non-January months.     

Using Expectations to Test Asset Pricing Models

Asset pricing models generate predictions relating assets' expected rates of return and their risk attributes. Most tests of these models have employed realized rates of return as a proxy for expected return. We use analysts' expected rates of return to examine the relation between these expectations and firm attributes. By assuming that analysts' expectations are unbiased estimates of market-wide expected rates of return, we can circumvent the use of realized rates of return and provide evidence on the predictions emanating from traditional asset pricing models. We find a positive, robust relation between expected return and market beta and a negative relation between expected return and firm size, consistent with the notion that these are risk factors. We do not find that high book-to-market firms are expected to earn higher returns than low book-to-market firms, inconsistent with the notion that book-to-market is a risk factor.     

The Cross-Section of Expected Stock Returns

Two easily measured variables, size and book-to-market equity, combine to capture the cross-sectional variation in average stock returns associated with market β, size, leverage, book-to-market equity, and earnings-price ratios. Moreover, when the tests allow for variation in β that is unrelated to size, the relation between market β and average return is flat, even when β is the only explanatory variable.     

Why does book-to-market value of equity forecast cross-section stock returns?

In this paper, we derive a model of book-to-market value of equity based on the present value model and estimate it using panel data on individual stocks. We explicitly include in the model all the determinants of book-to-market except the firm-specific discount rate, which we capture using fixed individual effects in the panel data model. The model is particularly successful, explaining nearly 90% of the time series and cross-section variation in the ratio of book-to-market value of equity. Moreover, the estimated firm-specific fixed effects are more successful than the most recent book-to-market value of equity in forecasting subsequent returns. This is consistent with an efficient market in which book-to-market is a proxy for risk.     

Default Risk and Equity Returns: Evidence from the Taiwan Equities Market

Studies of risk and return characteristics of different portfolios have recently gained enormous attention. Differing from past studies, this paper uses a compound option model to build the proxy of default risk and evaluate the relationship between default risk effect and equity returns. The primary goal of this paper is to evaluate the relationship among default risk, size, book-to-market, and equity returns, using data drawn from the Taiwan equities market, and to also examine whether size and book-to-market are proxies for default risk. The results show that the effects of size and book-to-market exist in different default portfolios when default risks are controlled. If size or book-to-market is controlled, there are no default effects. In the regression analysis, when default risk is included in Fama and French’s Three Factor Model, it shows that size, book-to-market and default risk have significant influence on equity returns and default risk is a systematic risk. Default risk is also more powerful in explaining returns when the compound option model is adopted for estimating default risks.     

New Evidence on Risk Factors, Characteristics and the Cross-Sectional Variation of Japanese Stock Returns

This paper examines whether the cross-sectional variations in stock returns are better described by systematic risk factors or by firm characteristics such as book-to-market ratios and market capitalization. It provides new evidence from the Japanese stock market based on the recent sample period from 2002 to 2007, which is not addressed in the existing literature. Also, the new results are derived from the generalized method of moments applied to daily returns. The evidence suggests that both the firm size and book-to-market ratio are significantly related to average return premiums. There is mixed evidence, which tends to lend stronger support to the characteristic model rather than the Fama-French three-factor model as more reflective of the return dynamics in the Japanese stock market.     

The conditional relation between dispersion and return

The main goal of this paper is to examine the conditional pricing effect of return dispersion on the cross section of returns. We observe a systematic conditional relation between dispersion and return even after controlling for market, size and book-to-market factors. However, we find that return dispersion risk is asymmetrically priced with a significantly positive premium observed during periods of large market gains only. The findings are found to be robust to alternative conditional specifications of market returns, suggesting asymmetric pricing effect of the return dispersion factor. We provide alternative explanations for the systematic risk captured by the return dispersion factor and discuss implications for portfolio management and corporate decisions.     

The evidence of bidders' overpayment in takeovers: the valuation ratios approach

Empirically, bidder returns at the time of takeover announcements are negative. This paper investigates the relation between bidder returns and overpayment in mergers and tender offers while controlling for other potentially important factors. Unlike other studies, the paper measures overpayment using two valuation ratios: earnings-price ratio and book-to-market ratio. Results show these ratios are important in explaining negative bidder returns. The paper also finds that the payment method in mergers and tender offers produces an information effect.     

Stock returns,dividend yield,and book-to-market ratio

A dividend yield model has been widely used in previous research that relates stock market valuations to cash flow fundamentals. Given controversies about using dividends as a proxy for cash flows, a loglinear book-to-market model has recently been proposed. However, these models rely on the assumption that dividend yield and book-to-market ratio are both stationary, and empirical evidence for this is, at best, mixed. We develop a new model, the loglinear cointegration model, that explains future profitability and excess stock returns in terms of a linear combination of log book-to-market ratio and log dividend yield. The loglinear cointegration model performs better than the log dividend yield model and the log book-to-market model in terms of cross-equation restriction tests and forecasting performance comparisons. The superior performance of the loglinear cointegration model suggests that the linear combination may be a better indicator of intrinsic fundamentals than the dividend yield or the book-to-market ratio separately.