Beta, Firm Size, Book-to-Market Equity and Stock Returns
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Veeraraghavan, M
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Abstract
The capital asset pricing model (CAPM), which has dominated finance theory for over thirty years, is concerned with the relationship between risk and the expected return on risky assets. According to the CAPM the market beta alone is sufficient to explain security returns and that there is a positive expected premium for investing in beta risks. However, evidence shows that the single risk factor is not quite adequate for describing the cross-section of stock returns. The current consensus is that firm size and book-to-market equity factors are pervasive risk factors besides the overall market factor. In this paper we compare the explanatory power of a single index model with the multifactor asset-pricing model of Fama and French (1996) for Hong Kong, Korea, Malaysia and the Philippines. Our findings suggest that the CAPM beta alone is not sufficient to describe the cross-section of expected returns. We also find that the absolute pricing errors of the CAPM are quite large when compared with the multifactor model of Fama and French (1996). Our findings show that firm size and book-to-market equity help explain the variation in average stock returns in a meaningful manner.
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Journal of the Asia Pacific Economy
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8
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3
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Applied economics
Applied economics not elsewhere classified
Banking, finance and investment
Policy and administration
Development studies