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Equilibrium Cross-Section of Returns

U of Pennsylvania, Wharton School Working Paper

Journal of Political Economy, Vol. 111, No. 4, 2003

71 Pages Posted: 13 Apr 2001 Last revised: 16 Sep 2009

Joao F. Gomes

The Wharton School

Leonid Kogan

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Lu Zhang

Ohio State University - Fisher College of Business; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: March 2001

Abstract

We explicitly link expected stock returns to firm characteristics such as firm size and book-to-market ratio in a dynamic general equilibrium production economy. Despite the fact that stock returns in the model are characterized by an intertemporal CAPM with the market portfolio as the only factor, size and book-to-market play separate roles in describing the cross-section of returns. These firm characteristics appear to predict stock returns because they are correlated with the true conditional market beta of returns. These cross-sectional relations can subsist after one controls for a typical empirical estimate of market beta. This lends support to the view that the documented ability of size and book-to-market to explain the cross-section of stock returns is not necessarily inconsistent with a single-factor conditional CAPM model. Our model also gives rise to a number of additional implications for the cross-section of returns. In this paper, we focus on the business cycle properties of returns and firm characteristics. Our results appear consistent with the limited existing evidence and provide a benchmark for future empirical studies.
cycle properties

Keywords: General equilibrium, the cross-section of returns, beta, size, book-to-market ratio, firm heterogeneity, business

JEL Classification: G120

Suggested Citation

Gomes, Joao F. and Kogan, Leonid and Zhang, Lu, Equilibrium Cross-Section of Returns (March 2001). U of Pennsylvania, Wharton School Working Paper; Journal of Political Economy, Vol. 111, No. 4, 2003. Available at SSRN: https://ssrn.com/abstract=264883 or http://dx.doi.org/10.2139/ssrn.264883

João F. Gomes

The Wharton School ( email )

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HOME PAGE: http://fnce.wharton.upenn.edu/profile/gomesj/

Leonid Kogan (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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HOME PAGE: http://web.mit.edu/lkogan2/www/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
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Lu Zhang

Ohio State University - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
585-267-6250 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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