Beta and Book-to-Market: Is the Glass Half Full or Half Empty?

Abstract

We review recent empirical work on the determinants of the cross-section of expected returns. This literature, which includes the influential work by Fama and French (1992, 1993), tends to ignore the positive evidence on beta and to overemphasize the importance of book-to-market. Kothari, Shanken, and Sloan (1995) show that beta significantly explains the cross-sectional variation in average returns, but that size also has incremental explanatory power. We find that, while statistically significant, the incremental benefit of size given beta is surprisingly small economically. Book-to-market is a weak determinant of the cross-sectional variation in average returns among large firms and it fails to account for returns from momentum strategies. This raises doubts about the forecasting power of book-to-market.