An empirical investigation of the book -to -market and size effects

• Main Author: Petkova, Ralitsa Grigorova
• Format: Dissertation
• Language: English
• Published: ProQuest Dissertations & Theses 01-01-2003
• Subjects: Bond portfolios; Business cycles; Capital assets; Consumption; Copyright; Default; Economic theory; Equity; Essays; Federal Reserve monetary policy; Finance; GDP; Gross Domestic Product; Growth stocks; Hedging; Inflation; Interest rates; Investments; Macroeconomics; Proxies; Rates of return; Risk premiums; Spread; Success; Value stocks; Variables; Volatility; Yield curve
• ISBN: 9780496498666; 0496498665

This paper consists of two essays. This first essay shows that the Fama-French factors HML and SMB are correlated with innovations in well-known variables that describe investment opportunities. HML is mostly related to a term spread surprise factor, while SMB is mostly related to a default spread surprise factor. A model that includes innovations to the aggregate dividend yield, the term spread, the default spread, and the one-month Treasury-bill yield explains the cross-section of average returns better than the Fama-French three-factor model. In addition, it captures common time-varying patterns in returns related to cross-sectional differences in sensitivities to lagged interest rates. When loadings on the innovations in the predictive variables are present in the model, loadings on HML and SMB lose their explanatory power for the cross-section of returns. The results are consistent with an ICAPM explanation for the empirical success of the Fama-French hedge portfolios. The second essay studies the time-varying risk patterns of value and growth stocks across business cycles. It finds reliable evidence that value stocks are riskier than growth stocks in bad times when the expected market risk premium is high, and to a lesser extent, growth stocks are riskier than value stocks in good times when the expected market risk premium is low. Methodologically, the time-variation of risk is measured by sorting the conditional betas on the theoretically justified expected market risk premium, as opposed to the ex post realized market excess return. The evidence lends support to the predictions of recent rational expectations theory on the value premium.