TAILIEUCHUNG - THE CROSS-SECTION OF EXPECTED STOCK RETURNS

An examination of the rest of Table 1 reveals that the results for these three additional indexes are similar to those for the DJIA. For all three indexes and for both return windows (a total of six return specifications), new moon returns are substantially higher than full moon returns. If anything, the return differences in Panels B, C, and D are somewhat larger than those for the DJIA in Panel A. The daily return differences range from a low of percent for the 15-day specification for the S&P 500 to a high of for the. | THE JOURNAL OF FINANCE VOL XLVII NO 2 JUNE 1992 The Cross-Section of Expected stock Returns EUGENE F. FAMA and KENNETH R. FRENCH ABSTRACT Two easily measured variables size and book-to-market equity combine to capture the cross-sectional variation in average stock returns associated with market i j size leverage book-to-market equity and earnings-price ratios. Moreover when the tests allow for variation in 3 that is unrelated to size the relation between market 0 and average return is flat even when 13 is the only explanatory variable. The asset-pricing model of Sharpe 1964 Lintner 1965 and Black 1972 has long shaped the way academics and practitioners think about average returns and risk. The central prediction of the model is that the market portfolio of invested wealth is mean-variance efficient in the sense of Markowitz 1959 . The efficiency of the market portfolio implies that a expected returns on securities are a positive linear function of their market 3s the slope in the regression of a security s return on the market s return and b market 3 s suffice to describe the cross-section of expected returns. There are several empirical contradictions of the Sharpe-Lintner-Black SLB model. The most prominent is the size effect of Banz 1981 . He finds that market equity ME a stock s price times shares outstanding adds to the explanation of the cross-section of average returns provided by market 3s. Average returns on small low ME stocks are too high given their 3 estimates and average returns on large stocks are too low. Another contradiction of the SLB model is the positive relation between leverage and average return documented by Bhandari 1988 . It is plausible that leverage is associated with risk and expected return but in the SLB model leverage risk should be captured by market 3. Bhandari finds however that leverage helps explain the cross-section of average stock returns in tests that include size ME as well as 3. Stattman 1980 and Rosenberg Reid and .

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