https://rady.ucsd.edu/faculty/directory/valkanov/pub/classes/mfe/docs/fama_french_jfe_1993.pdf

Common risk factors in the returns on stocks and bonds

Previous work shows that average returns on common stocks are related to firm characteristics like size, earnings/price, cash flow/price, book-to-market equity, past sales growth, long-term past return, and short-term past return. Because these patterns in average returns apparently are not explained by the CAPM, they are called anomalies. We find that, except for the continuation of short-term returns, the anomalies largely disappear in a three-factor model. Our results are consistent with rational ICAPM or APT asset pricing, but we also consider irrational pricing and data problems as possible explanations. RESEARCHERS HAVE IDENTIFIED MANY patterns in average stock returns. For example, DeBondt and Thaler (1985) find a reversal in long-term returns; stocks with low long-term past returns tend to have higher future returns. In contrast, Jegadeesh and Titman (1993) find that short-term returns tend to continue; stocks with higher returns in the previous twelve months tend to have higher future returns. Others show that a firm's average stock return is related to its size (ME, stock price times number of shares), book-to-marketequity (BE/ME, the ratio of the book value of common equity to its market value), earnings/price (E/P), cash flow/price (C/P), and past sales growth. (Banz (1981), Basu (1983), Rosenberg, Reid, and Lanstein (1985), and Lakonishok, Shleifer and Vishny (1994).) Because these patterns in average stock returns are not explained by the capital asset pricing model (CAPM) of Sharpe (1964) and Lintner (1965), they are typically called anomalies. This paper argues that many of the CAPM average-return anomalies are related, and they are captured by the three-factor model in Fama and French (FF 1993). The model says that the expected return on a portfolio in excess of the risk-free rate [E(Ri) - Rf] is explained by the sensitivity of its return to three factors: (i) the excess return on a broad market portfolio (RM - Rf); (ii) the difference between the return on a portfolio of small stocks and the return on a portfolio of large stocks (SMB, small minus big); and (iii) the difference between the return on a portfolio of high-book-to-market stocks and the return on a portfolio of low-book-to-market stocks (HML, high minus low). Specifically, the expected excess return on portfolio i is,

https://onlinelibrary.wiley.com/doi/pdf/10.1111/j.1540-6261.1996.tb05202.x

Multifactor Explanations of Asset Pricing Anomalies

Industry costs of equity

SEQUELS ARE RARELY AS good as the originals, so I approach this review of the market efficiency literature with trepidation. The task is thornier than it was 20 years ago, when work on efficiency was rather new. The literature is now so large that a full review is impossible, and is not attempted here. Instead, I discuss the work that I find most interesting, and I offer my views on what we have learned from the research on market efficiency.

https://onlinelibrary.wiley.com/doi/pdf/10.1111/j.1540-6261.1991.tb04636.x

Efficient Capital Markets: II

This paper tests whether innovations in macroeconomic variables are risks that are rewarded in the stock market. Financial theory suggests that the following macroeconomic variables should systematically affect stock market returns: the spread between long and short interest rates, expected and unexpected inflation, industrial production, and the spread between high- and low-grade bonds. We find that these sources of risk are significantly priced. Furthermore, neither the market portfolio nor aggregate consumption are priced separately. We also find that oil price risk is not separately rewarded in the stock market.

Economic Forces and the Stock Market

A test for the ex ante efficiency of a given portfolio of assets is analyzed. The relevant statistic has a tractable small sample distribution. Its power function is derived and used to study the sensitivity of the test to the portfolio choice and to the number of assets used to determine the ex post mean-variance efficient frontier. Several intuitive interpretations of the test are provided, including a simple mean-standard deviation geometric explanation. A univariate test, equivalent to our multivariate-based method, is derived, and it suggests some useful diagnostic tools which may explain why the null hypothesis is rejected. Empirical examples suggest that the multivariate approach can lead to more appropriate conclusions than those based on traditional inference which relies on a set of dependent univariate statistics.

https://www.jstor.org/stable/pdfplus/1913625.pdf

A test of the efficiency of a given portfolio

An integrated econometric view of maximum likelihood methods and more traditional two-pass approaches to estimating beta-pricing models is presented. Several aspects of the well-known errors-in-variables problem are considered, and an earlier conjecture concerning the merits of simultaneous estimation of beta and price of risk parameters is evaluated. The traditional inference procedure is found, under standard assumptions, to overstate the precision of price of risk estimates and an asymptotically valid correction is derived. Modifications to accommodate serial correlation in market-wide factors are also discussed.	 Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

/pdf/on-the-estimation-of-beta-pricing-models-1b4kradfa2.pdf

On the Estimation of Beta-Pricing Models

Our examination of the cross-section of expected returns reveals economically and statistically significant compensation (about 6 to 9 percent per annum) for beta risk when betas are estimated from time-series regressions of annual portfolio returns on the annual return on the equally weighted market index. The relation between book-to-market equity and returns is weaker and less consistent than that in Fama and French (1992). We conjecture that past book-to-market results using COMPUSTAT data are affected by a selection bias and provide indirect evidence. AN EXTENSIVE BODY OF empirical research over the past 10 to 15 years has provided evidence contradicting the prediction of the Sharpe (1964), Lintner (1965), and Black (1972) capital asset pricing model (CAPM) that the crosssection of expected returns is linear in beta. This research documents that deviations from the linear CAPM risk-return trade-off are related to, among other variables, firm size (e.g., Banz (1981)), earnings yield (e.g., Basu (1977, 1983)), leverage (e.g., Bhandari (1988)), and the ratio of a firm's book value of equity to its market value (e.g., Stattman (1980), Rosenberg, Reid, and Lanstein (1985), and Chan, Hamao, and Lakonishok (1991)). After carefully reexamining this research, a recent article by Fama and French (FF; 1992) draws two main conclusions about the cross-section of average stock returns. First, there is only a weak positive relation between average return and beta over the period 1941 to 1990, and virtually no relation over the shorter period 1963 to 1990. Second, firm size and book-to-market equity (B/M) do a good

https://www.jstor.org/stable/pdfplus/2329243.pdf

Another Look at the Cross-section of Expected Stock Returns

It has become standard practice in the cross-sectional asset-pricing literature to evaluate models based on how well they explain average returns on size-B/M portfolios, something many models seem to do remarkably well. In this paper, we review and critique the empirical methods used in the literature. We argue that asset-pricing tests are often highly misleading, in the sense that apparently strong explanatory power (high cross-sectional R2s and small pricing errors) in fact provides quite weak support for a model. We offer a number of suggestions for improving empirical tests and evidence that several proposed models don't work as well as originally advertised.

/pdf/a-skeptical-appraisal-of-asset-pricing-tests-p0ewpff0dz.pdf

A Skeptical Appraisal of Asset Pricing Tests

http://web.mit.edu/lewellen/www/Documents/AssetPricingTests.pdf

Jay Shanken

Papers

A test of the efficiency of a given portfolio

On the Estimation of Beta-Pricing Models

Another Look at the Cross-section of Expected Stock Returns

A Skeptical Appraisal of Asset Pricing Tests

A skeptical appraisal of asset pricing tests.