Are Value and Size Fundamentals Proxies for the Systematic Risk Factors?
42 Pages Posted: 27 Feb 2011
Date Written: February 26, 2011
Many papers claim that value and size fundamentals (book-to-price ratios and market capitalization) yield positive expected return premia because they are proxies for systematic risk factors in conditional and/or multi-factor CAPM. Much of empirical evidence to support this idea comes from cross-sectional regressions on the Fama and French characteristics-sorted portfolios. We test if, on the individual stock level, the premia on the value, size and other characteristics can be explained by the betas to the systematic risk factors. Our inference is based on a random coefficient panel data model. Confirming the findings of earlier literature, we report that premia on company fundamentals are correlated with shocks to macroeconomic factors. Company characteristics also help to forecast future returns covariances with these indicators. However, these covariances by themselves do not have sufficient explicative power over the panel of stock returns, so that the premia on the company characteristics cannot be attributed to their omission from the model. We conclude that there is no reliable evidence in favor of the risk-based explanations of the excess returns on company fundamentals.
Keywords: Stock Returns, Asset Pricing, Value Puzzle, Three-Factor Model, Company Fundamentals
JEL Classification: G10, G12, G14
Suggested Citation: Suggested Citation