Stock returns, size, and book‐to‐market equity

Abstract

Purpose

The purpose of this paper is to reinvestigate the performance of common stock returns with respect to two popularly known firm level characteristics: size and book‐to‐market ratio.

Design/methodology/approach

All of New York Stock Exchange, American Stock Exchange, and National Association of Securities Dealers Automated Quotations stocks between July 1926 and June 2007 are used, and divided into various size and book‐to‐market equity groups. The extension of the various versions of the simple Fama‐French model is implemented.

Findings

From the findings, it is inferred that: two risk factors based on the mimicking return for the size and book‐to‐market ratio play a significant role in capturing strong variation in stock returns; and volatility persistence can significantly improve the common risk factors' impact in explaining the time series variation in size and book‐to‐market sorted portfolios.

Research limitations/implications

In some sense, the model is based on only two firm level variables. In reality there exists plenty of other sources of average return anomalies. For a clearer understanding, an integration of various firm level characteristics would be an interesting issue to explore. A general equilibrium model that incorporates volatility exposure in a Fama‐French framework would be a challenging task as well.

Practical implications

The approach will help scholars and investment professionals make robust quantification of risk and average returns with respect to various measures of fundamental value.

Originality/value

The patterns in the monthly and yearly average excess returns with respect to two firm level characteristics, which documented are consistent with earlier studies. Even though the important role of firm level characteristics on the average‐return anomalies of common stocks is widely known, the approach is the very first that extends its support with respect to volatility models.

Citation

Simlai, P. (2009), "Stock returns, size, and book‐to‐market equity", Studies in Economics and Finance, Vol. 26 No. 3, pp. 198-212. https://doi.org/10.1108/10867370910974026