Cross-sectional Variation In Average Returns Research Articles

Asset pricing with data revisions

We document two important asset pricing implications of the data release process of US consumption growth. First, initial releases are more suitable for asset pricing than final revised releases. This is because most revisions smooth out essential short-term consumption growth fluctuations. Second, first revisions incorporate novel information and their magnitude is strongly linked to consumption growth ambiguity. We formulate a novel consumption-based model, the Revised CCAPM, which incorporates these two effects using vintage data. It explains a striking 75% of the cross-sectional variation in average returns on 25 size-value portfolios. These results support the concept of state-dependent ambiguity attitudes.

Comparative analysis of the explanatory power of the CAPM and the Fama-French three-factor model on cross-sectional variation of returns on stocks trading on the Official market of the Macedonian Stock exchange

The amount of literature on factors that explain the cross-sectional variation in average returns is vast, however, the majority of these papers attempt to explain the variation of returns in developed and emerging markets. In that sense, the literature lacks sufficient evidence regarding the variation of returns of frontier markets. The Republic of North Macedonia is considered to be a frontier market and in this paper we aim to empirically test the ability of the Capital Asset Pricing Model and the Fama-French Three Factor Model in explaining the cross-sectional variations of stock returns of securities trading on the Macedonian Stock Exchange. The empirical study is based on monthly returns from January 2011 to April 2021. Additionally, we use annual data obtained from the financial statements of the analysed companies included in this study. Using OLS time series regression we find that both models have limited explanatory power of the cross-sectional variation in expected returns on the Macedonian Stock Exchange. The study shows that only the size factor exhibits some limited explanatory power regarding stock returns. Based on the comparative analysis the Fama-French Three-Factor Model describes the variation of returns on the MSE much better than the Capital Asset Pricing Model.

Asset Pricing With Data Revisions

This paper documents the asset pricing implications of the data release process of National Income and Product Accounts (NIPA) consumption expenditure. We show that initial consumption data releases are more suitable for asset pricing than final revised releases. This is because most revisions smooth out important short-term consumption growth fluctuations. This also explains the documented success of non-revised proposals like garbage and electricity and unfiltered consumption which recover these lost short-term fluctuations. Yet, first revisions specifically incorporate novel information and their magnitude is strongly linked to uncertainty about consumption growth. On this basis, we formulate a new consumption-based model, the Revised CCAPM, which incorporates these effects from the release process using only NIPA vintage data. It explains a striking 75% of the cross-sectional variation in average returns on the 25 size-value portfolios, including a large part of the value premium, when featuring the first data release and state-dependent uncertainty coming from first revisions. These effects are consistent with investors' state-dependent ambiguity attitudes and are priced in the financial market as such.

The four-factor model and stock returns: evidence from Sri Lanka

There have been numerous studies that have attempted to explain the cross-sectional variation in average returns in developed and emerging markets. However, there is a dearth in the published evidence of research that has looked at frontier markets regarding this aspect. Sri Lanka is considered to be a frontier market and hence the objective of this study is to test the ability of the Carhart four-factor model to explain the variation in the cross-section of average stock returns in the Colombo Stock Exchange (CSE) and to evaluate it in comparison to the capital asset pricing model (CAPM) and the Fama and French three-factor model. The study finds that the four-factor model, incorporating the market factor, size factor, value factor and momentum factor, provides a satisfactory explanation of the variation in the cross-section of average stock returns in the CSE. Further, it is found that the four-factor model performs better than the CAPM and the three-factor model.

The Cost of Capital of the Financial Sector

Standard factor pricing models do not capture well the common time-series or cross-sectional variation in average returns of financial stocks. We propose a five-factor asset pricing model that complements the standard Fama and French (1993) three-factor model with a financial sector ROE factor (FROE) and the spread between the financial sector and the market return (SPREAD). This five-factor model helps to alleviate the pricing anomalies for financial sector stocks and also performs well for nonfinancial sector stocks compared with the Fama and French (2014) five-factor model or the Hou, Xue, and Zhang (2014) four-factor models. We find that the aggregate expected return to financial sector equities correlates negatively with aggregate financial sector ROE, which is puzzling, as ROE is commonly used as a measure of the cost of capital in the financial sector.

Size and value effects in Suriname

This article studies the link between stock returns and size and book-to-market equity effects for 10 companies listed at the Suriname Stock Exchange (SSE). We analyse the cross-sectional variation in average returns and we find that there is apparently no size effect, but there is a value effect. The findings are broadly in line with those for other emerging markets documented in the literature.

Future labor income growth and the cross-section of equity returns

This paper examines the equilibrium relation between future labor income growth and expected asset returns; it proposes revisions in the expectation of future labor income growth as a macroeconomic state variable and suggests a three-factor model, including a factor related to this variable, along with the consumption growth factor and the market factor. The proposed future labor income growth factor is positively associated with the Fama–French factors and subsumes their explanatory power in explaining the cross-section of stock returns. These results provide a possible economic explanation for the roles of the Fama–French factors: they are compensation for higher exposure to the risk related to changes in the value of human capital. This paper also compares the performance of the proposed three-factor model with other competing models and finds that the proposed model specification better captures cross-sectional variation in average returns than any of the competing asset pricing models considered.

Long-run cash flow and discount-rate risks in the cross-section of US returns

This paper decomposes the overall market beta of common stocks into four parts reflecting uncertainty related to the long-run dynamics of stock-specific and market-wide cash flows and discount rates. We employ a discrete time version of Merton's intertemporal capital asset pricing model to test whether these four sources of risk command different risk prices. The model performs well in pricing average returns on single- and double-sorted portfolios according to size, book-to-market, dividend-price ratios and past risk. It generates high estimates for the explained cross-sectional variation in average returns, lower average pricing errors than the Fama–French three-factor model and economically and statistically acceptable estimates for the coefficient of relative risk aversion.

Future Labor Income Growth and the Cross Section of Equity Returns

This paper examines the equilibrium relation between future labor income growth and expected asset returns; it proposes revisions in the expectation of future labor income growth as a macroeconomic state variable and suggests a three-factor model, including a factor related to this variable, along with the consumption growth factor and the market factor. The proposed future labor income growth factor is positively associated with the Fama-French factors and subsumes their explanatory power in explaining the cross section of stock returns. These results provide a possible economic explanation for the roles of the Fama-French factors: They are compensation for higher exposure to the risk related to changes in the value of human capital. This paper also compares the performance of the proposed three-factor model with other competing models and finds that the proposed model specification better captures cross-sectional variation in average returns than any of the competing asset pricing models considered.

Real Estate Risk in Equity Returns

In this paper, we investigate whether shocks to real estate markets constitute an important state variable in the context of the Intertemporal Capital Asset Pricing Model (ICAPM) and, hence, explain the cross-sectional variation in average returns of the 25 Fama-French portfolios sorted on size and book-to-market. We document that a real estate factor can explain much of the underlying risk inherent in the Fama-French size- and value-factors. In comparison to the Fama-French three-factor model, our alternative two-factor model including the real estate factor next to the market factor performs quite well in pricing the cross section of equity returns. Moreover, we provide evidence that the real estate factor is not captured by other sources of risk applied in the context of the ICAPM, such as shifts in credit market conditions and the stance of monetary policy, aggregate distress risk, and news related to future GDP growth.

Are accruals mispriced? Evidence from tests of an Intertemporal Capital Asset Pricing Model

This paper proposes a risk-based explanation for the accrual anomaly. Risk is measured using a four-factor model motivated by the Intertemporal Capital Asset Pricing Model. Tests of the model suggest that a considerable portion of the cross-sectional variation in average returns to high and low accrual firms is explained by risk. The four-factor model also performs better than some other widely used models in pricing a number of different hedge portfolios.

Are Accruals Mispriced? Evidence from Tests of an Intertemporal Capital Asset Pricing Model

This paper proposes a risk-based explanation for the accrual anomaly. Risk is measured using a four-factor model motivated by the Intertemporal Capital Asset Pricing Model. Tests of the model suggest that a considerable portion of the cross-sectional variation in average returns to high and low accrual firms is explained by risk. The four-factor model also performs better than some other widely used models in pricing a number of different hedge portfolios.

Idiosyncratic Consumption Risk and the Cross-Section of Asset Returns

This paper investigates the importance of idiosyncratic consumption risk for the cross-sectional variation in average returns on stocks and bonds. If idiosyncratic consumption risk is not priced, the only pricing factor in a multiperiod economy is the rate of aggregate consumption growth. We offer evidence that the cross-sectional variance of consumption growth is also a priced factor. This demonstrates that consumers are not fully insured against idiosyncratic consumption risk, and that asset returns reflect their attempts to reduce their exposure to this risk. We find that over the sample period the resulting two-factor consumption-based asset pricing model significantly outperforms the CAPM. The model's empirical performance also compares favorably with that of the Fama-French three-factor model. Moreover, in the presence of the market factor and the size and book-to-market factors, the two consumption based factors retain explanatory power. Together with the results of Lettau and Ludvigson (2000), these findings indicate that consumption-based asset pricing is relevant for explaining the cross-section of asset returns.

Market Frictions, Price Delay, and the Cross-Section of Expected Returns

We parsimoniously characterize the severity of market frictions affecting a stock using the delay with which its share price responds to information. The most severely delayed firms command a large return premium that captures the size effect and half the value premium. Moreover, idiosyncratic risk is priced only among the most delayed firms. These results are not explained by other sources of return premia, microstructure, or pure liquidity effects, but appear most consistent with investor recognition and firm neglect. The very small segment of neglected firms (less than 0.02% of the market) captures a sizeable amount of cross-sectional variation in average returns.

CAPM anomalies and the pricing of equity: evidence from the Hong Kong market

Using a sample of equity stocks traded on the Hong Kong stock market, this study examines empirically the independent and joint roles of the more commonly hypothesized variables in explaining cross-sectional variation in average returns over the period from January 1980 to December 1994. Evidence indicates that beta, book leverage, earnings-price ratio and dividend yield are not priced, whereas significant book-to-market equity, market leverage (absorbed by book-to-market equity), size, and share price effects are observed. The findings should prove valuable in portfolio management and corporate financial decisions.

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

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.

Multifactor Asset Pricing Analysis of International Value Investment Strategies

Using a large international equity market database that has not been previously used for such a purpose, this paper documents that value (i.e., high book-to-market ) stocks outperform growth (i.e., low book-to-market ) stocks, on average, in most countries during the January 1975 - December 1995 period, both absolutely and after adjusting for risk. The international evidence confirms the findings of previous work reported for the U.S.. For 1975-1995, the annual difference between the average returns on portfolios of high and low book-to-market stocks is 12.94% in North America, 10.42% in Europe, 17.26% in Pacific-Rim per year, and value stocks outperform growth stocks in 17 out of 18 national capital markets. Our analysis also shows that a three-factor model explains most of the cross-sectional variation in average returns on industry portfolios across countries and that the superior performance of the value investing strategy, documented in this study, is a manifestation of size and book-to-market effects. These results are consistent with those reported by Fama and French (1994, 1996) that show that the value-growth pattern in stock returns is largely explained by a three-factor asset pricing model. Our results suggest that the Fama and French (1996) three-factor asset pricing model is not limited to the U.S. stock market.

Multifactor Asset Pricing Analysis of International Value Investment Strategies

Using a large international equity market database that has not been previously used for such a purpose, this paper documents that value (i.e., high book-to-market ) stocks outperform growth (i.e., low book-to-market ) stocks, on average, in most countries during the January 1975 - December 1995 period, both absolutely and after adjusting for risk. The international evidence confirms the findings of previous work reported for the U.S.. For 1975-1995, the annual difference between the average returns on portfolios of high and low book-to-market stocks is 12.94% in North America, 10.42% in Europe, 17.26% in Pacific-Rim per year, and value stocks outperform growth stocks in 17 out of 18 national capital markets. Our analysis also shows that a three-factor model explains most of the cross-sectional variation in average returns on industry portfolios across countries and that the superior performance of the value investing strategy, documented in this study, is a manifestation of size and book-to-market effects. These results are consistent with those reported by Fama and French (1994, 1996) that show that the value-growth pattern in stock returns is largely explained by a three-factor asset pricing model. Our results suggest that the Fama and French (1996) three-factor asset pricing model is not limited to the U.S. stock market.