TAILIEUCHUNG - CONDITIONING VARIABLES AND THE CROSS SECTION OF STOCK RETURNS

The main reason for this lack of statistical significance is the large standard deviation of daily returns, about 1 percent, which swamps in magnitude the difference in returns. We also investigate whether the identified difference in returns between new moon and full moon windows is persistent. As a measure of persistence, we calculate the percentage of years in which mean new moon daily returns are higher than mean full moon returns. For the DJIA, this number is percent, which is moderately above the 50 percent that would be expected by chance. This percentage also signifies. | THE JOURNAL OF FINANCE VOL. LIV NO. 4 AUGUST 1999 Conditioning Variables and the Cross Section of Stock Returns WAYNE E. FERSON and CAMPBELL R. HARVEY ABSTRACT Previous studies identify predetermined variables that predict stock and bond returns through time. This paper shows that loadings on the same variables provide significant cross-sectional explanatory power for stock portfolio returns. The loadings are significant given the three factors advocated by Fama and French 1993 and the four factors of Elton Gruber and Blake 1995 . The explanatory power of the loadings on lagged variables is robust to various portfolio grouping procedures and other considerations. The results carry implications for risk analysis performance measurement cost-of-capital calculations and other applications. Empirical asset pricing is in a state of turmoil. The Capital Asset Pricing Model CAPM see Sharpe 1964 and Black 1972 has long served as the backbone of academic finance and numerous important applications. However studies have identif ied empirical def iciencies in the CAPM challenging its preeminence. The most powerful challenges include market capitalization and related financial ratios that can predict the cross section of returns. For example the firm size-effect drew attention as a challenge to the CAPM. Ratios of stock market price to earnings or the book value of equity are studied by Basu 1977 Banz 1981 Chan Hamao and Lakonishok 1991 and Fama and French 1992 among others. With the CAPM under such strenuous attack the field is hungry for a replacement There are some natural heirs waiting in the wings including the intertemporal equilibrium models of Merton 1973 and Breeden Ferson is the Pigott-PACCAR Professor of Finance at the University of Washington and a Research Associate of the National Bureau of Economic Research NBER . Harvey is the J. Paul Sticht Professor of International Business at Duke University and a Research Associate of the NBER. We are grateful to .

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• Acknowledgements