The cross section of expected stock returns the evidence. The famafrench threefactor model explains over 90% of the diversified portfolios returns, compared with the average 70% given by the capm within sample. If aggregate volatility is a risk factor that is orthogonal to existing risk factors, the sensitivity of stocks. Mar 01, 2017 we predict that book tomarket strategies work because the retained earnings component of the book value of equity includes the accumulation and, hence, the averaging of past earnings. We find that a large book market ratio increase, i.
The question addressed by the authors is whether past changes in the elements of a decomposed bm are related to future returns on securities traded in six nonu. Bookmarket fluctuations, trading activity, and the crosssection of expected stock returns we analyze trading activity accompanying equities switches from growth low book tomarket ratios to value high book tomarket ratios, and vice versa. Our thesis is that the components of the booktomarket ratios numerator the accounting book value of equity contain different information about the cross section of stock returns and that differences in their informativeness can shed light on the source and interpretation of booktomarkets predictive ability for the cross section of. For example, gomes, kogan and zhang 2003 develop a stochastic dynamic general equilibrium model in which the crosssection of expected returns depends on rm size and book. Nikolaev, earnings, retained earnings, and book tomarket in the cross section of expected returns, journal of financial economics, forthcoming, 2018with j. Portfolio inefficiency and the crosssection of expected. Government spending, political cycles, and the cross. We examine both the pre and post1990 periods, since the structure of the reit market changed substantially around 1990. While our focus is on the crosssection of equity returns, our message. Banking, finance and accounting business liquidity finance portfolio management methods ratio analysis time series analysis timeseries analysis. I extract a predictor for longterm returns from the book tomarket ratio bm by using a crosssectional regression to control for bms ariationv associated. The book tomarket ratio bm is known to be a noisy measure of expected u.
Earnings, retained earnings, and booktomarket in the cross section. Expected return itself is the summary characteristic, and level slope and curvature of expected returns is. Earnings, retained earnings, and book tomarket in the cross section of expected returns. On the following page is an excerpt of a table replicated from the cross section of expected stock returns journal of finance, fama and french1992. Cross section of expected returns and extreme returns.
Funding liquidity and the cross section of stock returns adrian and etula, 2010 and intermediary leverage and the crosssection of expected returns muir, 2010. First, we cross sectionally estimate a price of risk for aggregate market volatility. After jointly evaluating the roles of beta, firm size, book tomarket, earningstoprice and leverage, they observed that while beta was not associated with expected returns, firm size and book tomarket were, and in a manner that absorbed. The cross section of expected stock returns abstract this paper studies the crosssectional properties of return forecasts derived from famamacbeth regressions. Asset pricing we examine the pricing of aggregate volatility risk in the crosssection of stock returns. Second, the ratio of book tomarket equity and size are found to be the most significant variables that can account for the crosssection of expected stock returns. Given this extensive data mining, it does not make any. January 15, 2018 abstract the population growth of captive asian elephants explains the crosssection of expected returns of sizevalue sorted portfolios with a crosssectional r2 of 93% and a tstatistic. The crosssection of expected stock returns eugene f. Interpret the relevant section in the table and explain the manifestation of why fama and french suggest that the capm should be augmented with book tomarket to describe stock returns in the crosssection. The determinants of expected returns differ between the two subperiods. Given this extensive data mining, it does not make sense to use the usual criteria for establishing significance. We show that, if characteristics are a good proxy for expected returns, then forming cps by sorting on characteristics alone will generally not explain the cross section of returns in the way proposed in the literature.
Hundreds of papers and factors attempt to explain the cross section of expected returns. Habit formation, the cross section of stock returns and the. The cross section of expected returns with midas betas. We therefore predict either no relation or a weak negative relation between contributed capital and the cross section of expected returns. These forecasts mimic how an investor could, in real time, combine many firm characteristics to get a composite estimate of a stocks expected return. The conditional beta and the crosssection of expected. Reliable information about the coronavirus covid19 is available from the world health organization current situation, international travel. We provide a systematic study of how stochastic volatility is priced in the cross section of expected stock returns. Earnings, retained earnings, and booktomarket in the cross.
The crosssection of expected stock returns critical finance. As a result, both shareholders and management have a claim on the. Earnings, retained earnings, and booktomarket in the. Past studies using options have estimated a negative price for market volatility. Portfolio inefficiency and the crosssection of expected returns.
The authors thank ariel zucker and daniel green for outstanding research assistance. Thus, they conclude that beta is neither a single relevant risk measure nor a subset of. Booktomarket and the crosssection of expected returns. Earnings, retained earnings, and booktomarket in the cross section of expected returns ray bally 1, joseph gerakos2, juhani t. Asset pricing hundreds of papers and hundreds of factors attempt to explain the crosssection of expected returns. Outofsample forecasts from fm regressions provide a simple, yet surprisingly effective, way to form a composite trading strategy going long high expected return stocks.
The cross section of expected stock returns 3 available at the time i. A reexamination of firm size, booktomarket and earnings. Parker princeton university and national bureau of economic research christian julliard princeton university this paper evaluates the central insight of the consumption capital asset pricing model that an assets expected return is determined by its equilibrium risk to. A 2008 study by eugene fama and kenneth french found evidence that past changes in book equity and price contain independent information about expected cash flows that can be used to improve estimates of expected returns. Section of expected stock returns wiley online library. Booktomarket and the crosssection of expected returns in. What is cross section in cross section of stock return. Linnainmaa3,4 and valeri nikolaev 1university of chicago booth school of business, united states. Banking, finance and accounting business rate of return analysis return on investment stocks forecasts and trends.
Two easily measured variables, size me and book tomarket equity. Using the sample period of december 2004 through july 2011, we study the sample of 4 companies out of a universe of 176 companies. The cross section of expected stock returns 429 also possible, however, that beme just captures the unraveling regression toward the mean of irrational market whims about the prospects of firms. On the following page is an excerpt of a table rep. Consumption risk and the cross section of expected returns jonathan a. However, the use of options to estimate price does not control for cross sectional risk factors, such as book value, size, momentum, or liquidity factors used in previous studies. However, the bestknown work on the value factor was carried out by eugene fama and kenneth french in their 1992 paper, the crosssection of expected stock returns, which concluded that low priceto book ratio was the most predictive definition of value. Portfolio sorts and tests of crosssectional patterns in. Consumption risk and the cross section of expected returns. Earnings, retained earnings, and book tomarket in the cross section of expected returns ray bally 1, joseph gerakos2, juhani t. The volatility of cross sectional stock returns is known to vary over time. Citations of the crosssection of expected stock returns.
Numerous and frequentlyupdated resource results are available from this search. Cross section of volatility and expected returns 261 of assets that may have different exposures to aggregate volatility and hence different average returns. Two easily measured variables, size and book tomarket equity, combine to capture the crosssectional variation in average stock returns associated with market. To test more directly our thesis that book tomarket contains information about expected returns because book values contain accumulated past earnings, we next examine whether retained earnings predictive power arises from earnings or dividends. Bookmarket fluctuations, trading activity, and the cross. The productivity of cash and the crosssection of expected.
The efficiency of the market portfolio implies that a expected returns on securities are a positive linear function of their market. The role of investor attention and risk preferences. The crosssection of expected stock returns 429 also possible, however, that beme just captures the unraveling regression toward the mean of irrational market whims about the prospects of firms. Competition, productivity, organization and the cross section of. The crosssection of expected stock returns 3 available at the time i. However, formatting rules can vary widely between applications and fields of interest or study. Financial intermediaries and the crosssection of asset. On the crosssectional relation between expected returns. The cross section of expected stock returns author. A reexamination of firm size, book tomarket and earnings price in the crosssection of expected stock returns. Organization capital and the crosssection of expected returns.
The crosssection of volatility and expected returns book. Hundreds of papers and factors attempt to explain the crosssection of expected returns. How average returns change across different stock or portfolios. We examine the pricing of aggregate volatility risk in the cross section of stock returns. We construct the marketwide indicators of famafrench approach. The crosssection of expected stock returns summary studeersnel. But are there really dozens if not more priced factors. Our goal is to provide guidance as to the appropriate significance level using a multiple testing framework. Retained earningstomarket predicts the cross section of average returns in u. Pdf crosssectional determinants of expected returns.
Tail risk and the crosssection of mutual fund expected returns. We then derive implications for the crosssection of expected returns, and. But the true crosssectional expected return beta relation is exact when the index is efficient, so no variable other than beta can explain any part of the true crosssection of expected returns. Ep is likely to be higher prices are lower relative to earnings for stocks with higher risks and expected returns, whatever the unnamed sources of risk. Crosssection of volatility and expected returns 261 of assets that may have different exposures to aggregate volatility and hence different average returns. Hundreds of papers and hundreds of factors attempt to explain the crosssection of expected returns.
A fished expected return need not correspond to a covariance. Size and booktomarket factors in earnings and returns. Given that so many papers have attempted to explain the same crosssection of expected returns, statistical inference should not be based on a single test perspective. We study a sample of the companies listed on the nepal stock exchange nepse for the predictors of the returns on these companies stocks. The crosssection of volatility and expected returns. Crosssection of expected returns and extreme returns. Oclcs webjunction has pulled together information and resources to assist library staff as they consider how to handle coronavirus. The cross section of expected returns with midas betas mariano gonz. For example, gomes, kogan and zhang 2003 develop a stochastic dynamic general equilibrium model in which the crosssection of expected returns depends on rm size and booktomarket ratio. Nikolaev, earnings, retained earnings, and book tomarket in the cross section of expected returns, journal of financial economics, forthcoming, 2018. Barclays back testing confirms this finding as it shows that stocks with a low pb outperform stocks with a high pb by 7% annualized over the last 10 years. The cross section of expected reit returns abstract in this study, we examine the cross sectional determinants of expected reit returns.
Given this extensive data mining, it does not make sense to use the usual criteria for establishing. We first show, analytically, that the expected return on the stock, firm size, and the book tomarket ratio bm are functionally dependent on the productivity of cash, defined as. Pricecash flow and pricebook are best at value screening. The argument is based on the early insights of markowitz 1952 and roll 1977. Individual stocks expected return estimates are a key input for equity selection models. So intuitively, if you study the cross section of stock returns, you want to answer the question why stock a earns higherlower returns than stock b. The assetpricing literature finds significant crosssectional predictability in stock returns. Book value of equity consists of two economically different. The productivity of cash and the crosssection of expected stock returns abstract. Tail risk and the crosssection of mutual fund expected returns nikolaos karagiannisand konstantinos tolikas abstract we test for the presence of a tail risk premium in the crosssection of mutual fund returns and. Eisfeldty ucla dimitris papanikolaouz northwestern university july 2011 abstract organization capital is a production factor that is embodied in the rms key talent and has an e ciency that is rm speci c. Ball 1978 argues that ep is a catchall proxy for unnamed factors in expected returns. Retained earnings, and booktomarket in the cross section of expected returns.
The remarkable multidimensionality in the crosssection of. Brokerdealer leverage and the crosssection of expected returns. Second, the ratio of book tomarket equity and size are found to be the most significant variables that can account for the cross section of expected stock returns. The crosssection of volatility and expected returns andrew ang, robert j. The cross section of expected stock returns summary. The hml return is the difference in average returns between two high and two low book tomarket portfolios. Conversely, if the index is not efficient, the ex ante crosssectional.
Abstract two easily measured variables, size and book. Citeseerx document details isaac councill, lee giles, pradeep teregowda. Earnings, retained earnings, and book tomarket in the. Out of sample forecasts from fm regressions provide a simple, yet surprisingly effective, way to form a composite trading strategy going long high expected return stocks. Lakonishok 1991 find that booktomarket equity, beme, also has a strong role in explaining the crosssection of average returns on japanese stocks. Government spending, political cycles, and the cross section of stock returns. The cross section of longterm expected returns zhongjin lu june 5, 2016 abstract e ective capital budgeting decisions require reliable estimates of longterm expected returns. However, since that time, hundreds of papers have tried to explain the crosssection of expected returns. Elephants and the crosssection of expected returns nora laurinaitytex christoph meinerdingy christian schlagz julian thimme this version. Organization capital and the crosssection of expected returns andrea l. Hodrick, yuhang xing, and xiaoyan zhang nber working paper no. Associate professor of finance department of economics and finance college of business.
They find positive returns from small size as well as value factors, high book tomarket ratio and related ratios. Fama and french have determined in their crosssection of expected returns study that the price to book pb ratio explains stocks returns better than any other financial ratio. On both issues, im still a fan of charles clarkes synthesis. Hence, stocks with different sensitivities to innovations in aggregate volatility should have different expected returns. Thus, fmbased estimates of expected returns appear to be somewhat more accurate for smaller stocksreflecting, in part, the substantial crosssectional variation in their true expected returnsbut are also informative about true expected returns even among larger stocks. G12, g abstract we examine the pricing of aggregate volatility risk in the cross section of stock returns. Fama and french 1992 find that two variables, market equity me and the ratio of book equity to market equity beme capture much of the cross section of average stock returns. Common risk factors in the returns on stocks and bonds. Motivated by the additional existing evidence that investors have a preference for lotterylike assets, i.
Firm characteristics such as size, booktomarket equity. Abstract this paper explores the crosssectional variation of expected returns for a large cross section of industry and sizebooktomarket portfolios. P, leverage, and book tomarket equity in the cross section of average stock returns. The conditional beta and the cross section of expected returns. The cross section of volatility and expected returns andrew ang, robert j. Whatever the underlying economic causes, our main result is straightfor ward. The crosssection of volatility and expected returns digest. We predict that book tomarket strategies work because the retained earnings component of the book value of equity includes the accumulation and, hence, the averaging of past earnings. This paper identities five common risk factors in the returns on stocks and bonds. The conditional beta and the crosssection of expected returns.
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