On the Cross Section of Conditionally Expected Stock Returns
44 Pages Posted: 8 Mar 2004
Date Written: October 28, 2005
We test and find evidence against Sharpe (1964) and Lintner's (1965) CAPM using portfolios motivated by Campbell's (1993) ICAPM, which is our alternative hypothesis. That is, we sort stocks equally into ten portfolios according to out-of-sample forecasts formed using predictive variables advocated by recent authors. The average out-of-sample realized returns of these portfolios increase monotonically from the first decile(stocks with the lowest expected returns) to the tenth decile (stocks with the highest expected returns), and the difference between the tenth and first deciles is a statistically significant 4.8 percent per year. These results are shown to be distinct from the momentum anomaly documented by Jegadeesh and Titman (1993). As expected, these portfolio returns pose a challenge to CAPM; however, they are explained by a variant of Campbell's ICAPM, in which risk factors also include the variables used to form the expected returns, in addition to stock market returns.
Keywords: Stock Return Predictability, Cross Section of Stock Returns, Size Premium, Value Premium, and Momentum Profit
JEL Classification: G1
Suggested Citation: Suggested Citation