Common Risk Factors In The Returns On Stocks

Topics: Stock, Stock market, Security Pages: 41 (1169 words) Published: March 6, 2015
Common Risk Factors in the Retu
rns on Stocks and Bonds
Eugene F. Fama
Kenneth R. French
Journal of Financial Economics 1993
Presenter: 周立軒

Brief Saying…
• This paper identifies Five common risk factors
in the return on stocks and bonds
– Two stock market factors, two bond market factors
, one market factor.
– The five factors seems to explain all returns in stoc
k market and bond market
• Except the Low-Grade Bonds

Agenda






Introduction
The Steps of the Experiment
Data & Variables
Main Result
Conclusion

Introduction
• The market βs of Sharpe-Litner, and Breedon’s c
onsumption βs show little relation of the Cross-S
ectional average returns on U.S common stocks.
• Empirical variables determined average returns
are:
– Size, Leverage, E/P, BE/ME [Banz(1981), Bhandari(19
88), Basu(1983), and Rosenberg, Reid, and Lanstein(1
985)]

Introduction
• If the market is aggregated, there must be so
me common factors which can explain both t
he common stock market and bond market .
• But for bond market, the factors used to explai
n common stock market may not appropriate.
– So, the new variables are introduced in this paper

The Steps for the Experiment
Choose the Data
from Database

Sort the data by
“Size” and “BE/ME”

Test the bond
factors on market
excess return

Test the market
factors on market
excess return

Test the stock
factors on market
excess return

Test the stock
factors + market
factors on market
excess return

Test all factors on
market excess
return

Test the adjusted
market factors on
market excess
return

To be continued…

Data & Variables
• Data
– From 1963 to 1991
– At least appeared on COMPUSTAT for two years
– Stock price in December on t-1 year and June on t
year in CRSP, and book equity in December on t-1
year on COMPUSTAT

Data &Variables
BE/ME

SIZE

Divided by
Median of NYSE

Lowest
30%

Medium
40%

Highest
30%

LOW

MEDIAN

HIGH

SMALL

S/L

S/M

S/H

BIG

B/L

B/M

B/H

Data &Variables
• In experiment, the sample will separate into 2
5 portfolios
– First ranked by size, than by BE/ME

Data & Variables
• Why sorting data by SIZE & BE/ME into those
number of groups?
– The test for these criteria are not sensitive in Fam
a&French(1992)

• After grouping the data, we can start to defin
e the experimental variables

Data & Variables
NAME

Description

RF

One-Month T-bill rate

RM

Average of all 25 Portfolios monthly return

SMB

Small-Minus-Big =
AVG(S/L + S/M + S/H) – AVG(B/L + B/M +B/H), in
percentage, monthly.

HML

High-Minus-Low=
AVG(S/H + B/H) – AVG(S/L + B/L ), in percentage, monthly.

TERM

Long-Term government bond – RF, in percentage, monthly.

DEF

Return of market portfolio of long-term corporate bonds –
Long-Term government bond, in percentage, monthly

Main Result – Bond Market Factor

Main Result – Bond Market Test

Main Result – Market Factor

Main Result – Market Factor

Main Result – Stock Market Factor

Main Result – Stock Market Factor

Main Result – A short break
• Even though the market factor, β, seems have
explained most part of the variance of stock m
arket, the result still leave room to improve. B
ut ,indeed, it capture more common variation
for both market.
• The bond market factors work well in capturin
g the common variation of bond market and s
tock market.

Main Result – A short break
• The stock market factors, used alone, cannot e
xplain the variation of bonds well. But they ha
ve some ability to explain the variation of stoc
k market.
– How about mix the stock market factors with mark
et factor?

Main Result – Stock Market Factors + Market Factor

Main Result – Stock Market Factors + Market Factor

Main Result
• Adding the stock market factors makes the ma
rket β move closed to 1.
– That’s probably because the RM – Rf have some c...
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