92Fama - The Cross-Section of Expected Stock Returns Fama...

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The Cross-Section of Expected Stock Returns Fama and French (JF, June 1992) Motivation: CAPM predicts: expected return of a security is a positive linear function of its β . β is su cient. Empirical contradictions: Banz (1981) size e f ect. MEs have additional explanatory power for the cross-section of average returns. Small stocks outperform large stocks. Bhandari (1988) leverage e f ect. Leverages are positively related to aver- age returns even controlling size and β . Stattman (1980) and Rosenberg et al (1985) book-to-market e f ect. The BE/ME ratios are positively related to the average returns. Chan and Chen (1991) argue BE/ME is the relative distress factor. Low stock price relative to its book value, signals poor prospects, which pare penalized with higher costs of capital. Basu (1983) earnings-to-price e f ect. E/Ps help explain the cross-section of average returns after controlling size and β . Since E/P, ME, leverage and BE/ME are all scaled versions of price, it is reasonable to expect that some of them are redundant for describing average returns. Findings: The relation between average stock returns and β disappears during 1963- 90 period, but the relations between average return and size, leverage, E/P, and BE/ME are strong. The combination of size and BE/ME seems to absorb the roles of leverage and E/P in stock returns during sample period. I. Preliminaries: A. Data, 7/1963-12/1990 (330-month). Exclude nancial rms: the high leverage that is normal for these rms does not have the same meaning as for non nancial rms, where high leverage more likely indicates distress. B. Estimating market
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This note was uploaded on 02/22/2012 for the course ACCT 1310 taught by Professor Staff during the Fall '10 term at Texas State.

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92Fama - The Cross-Section of Expected Stock Returns Fama...

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