Anomalies and Stock Returns: Australian Evidence

Abstract

Prior research has identified the existence of several cross-sectional patterns in equity returns, commonly referred to as effects. This paper empirically tests for the existence of a number of well known effects using data from the Australian equities market. Specifically, we investigate the size effect, book-to-market effect, earnings to price effect, cash flow to price effect, leverage effect and the liquidity effect. Fama and French (1996) note that patterns in average returns that cannot be explained by the traditional Capital Asset Pricing Model (CAPM) are considered anomalies. An additional aim of this paper is to investigate the capability of the CAPM and the Fama and French (1993) multifactor model (FFM) in explaining any observed anomalies. We document a size, book to market, earnings to price and cash flow to price effect but fail to find evidence of a leverage or liquidity effect. Although our results indicate that the FFM is superior to the CAPM in explaining cross-sectional variation in equity returns, we conclude that its performance is less than satisfactory in Australia.

Keywords: Anomalies, Fama-French model, Size effect, BE/ME effect

JEL Classification: G12, G14