Nama : Lidya Kumala Dewi

NIM : 00000006430
Fama French (1992)

I. Research Question
1. How is size and book-to-market equity combine to capture the cross sectional
variation in average stock returns associated with the market , size, leverage, book-
to-market equity, and earnings-price ratios? (how the joint roles of market , size,
E/P, leverage, and book-to market equity in the cross section of average returns on
NYSE, AMEX, and NASDAQ stocks?)
2. What is the relationship between market and average return when the unrelated to
size?

II. Hypothesis
The previous research finds:
- According to Markowitz (1959), the efficiency of the market portfolio implies that
expected returns on securities are a positive linear function of their market s (the
slope in the regression of a securitys return on the markets return) and market s
suffice to describe the cross section of expected returns. Leverage risk should be
captured by the market .
- Banz (1981) if there is the size effect, across-section of average returns provided
by market s. Average returns on small (low market equity) stocks are too high
given their estimates, and average returns on large stocks are too low.
- Bhandari (1988) Positive relation between leverage and average return. It is
plausible that leverage is associated with risk and expected return. Cross section
of average stocks returns in tests that include size (market equity) as well as .
- Stattman (1980) Average returns on stocks are positively related to the ratio of a
firms book value of common equity to its market value.

1. Size (market equity) and book-to-market equity provide a simple and powerful
characterization of the cross section of average stocks return for the 1963-1990
periods.
2. does not seem to help explain the cross section of average stock returns
3. The combination of size and book-to-market equity seems to absorb the roles of
leverage and E/P in average stocks returns.
4. There is a positive relation between and average return, but the relation is obscured
by noise in the estimates.
5. E/P should be related to expected returns, whatever the omitted sources of risk.

III. Data

The data are from all nonfinancial firms in the intersection of the NYSE, AMEX, and
NASDAQ return files from the Center of Research in Security Prices (CRSP) and the merged
COMPUSTAT annual industrial files of income statement and balance sheet data, also
maintained by CRSP. Financial firms are excluded because the high leverage that is normal
for these firms probably does not have the same meaning as for nonfinancial firms, where
high leverage more likely indicates distress. The CRSP returns cover NYSE and AMEX
stocks until 1973 when NASDAQ returns also come on line. The COMPUSTAT data are for
1962-1989. The 1962 start date reflects the fact that book value of common equity
(COMPUSTAT item 60), is not generally available prior to 1962. COMPUSTAT data for
earlier years have a serious selection bias; the pre-1962 data are titled toward big historically
successful firms.

To ensure that the accounting variables are known before the returns they are used to explain,
we match the accounting data for all fiscal year ends in calendar year t-1 (1962-1989) with
the returns for July of year t to June of t+1.

The journal also use a firms market equity at the end of December of year t-1 to compute its
book-to-market, leverage, and PER for t-1, and we use its market equity for June of year t to
measure its size.

IV. Empirical Model

V. Operationalization of the Variables

1. estimation
The as the sum of slopes in the regression of the return on a portfolio on the current
and prior months market returns. Full period estimates for portfolios can work well
in tests of the SLB model, even if the true s of the portfolio vary through time, if the
variation in the s is proportional.

The book-to-market, leverage, and PER for t-1 is compute using the firms market equity at
the end of December of year t-1, and use its market equity for June of year t to measure its
size.

The asset pricing tests use the cross-sectional regression approach of Fama and MacBeth
(1973). Each month the cross-section of returns on stocks is regressed on variables
hypothesized to explain expected returns. The time series means of the monthly regression
slopes then provide standard test of wether different explanatory variables are on average
priced.
 2. Average returns
Table III shows time-series averages of the slopes from the month-by-month Fama-
MacBeth (FM) regressions of the cross-section of stock returns on size, , and the other
variables (leverage, E/P, and book-to-market equity) used to explain average returns.
Table IV shows average returns for July 1963 to December 1990 for portfolios formed on
ranked values of book-to-market equity (BE/ME) or earnings-price ratio (E/P). The BE/ME
and E/P portfolios in Table IV are formed in the same general way (one-dimensional yearly
sorts) as the size and portfolios in Table II.

3. Leverage
We use two leverage variables, the ratio of book assets to market equity, A/ME, and the ratio
of book assets to book equity, A/BE. We interpret A/ME as a measure of market leverage,
while A/BE is a measure of book leverage. The regressions use the natural logs of the
leverage ratios, ln(A/ME) and ln(A/BE),

4. E/P
Thus, the slope for E/P in the FM regressions is based on positive values; we use a dummy
variable for E/P when earnings are negative.

5. Size Portfolios
Average Returns, Post-Ranking s and Fama-MacBeth Regression Slopes for Size Portfolios
of NYSE Stocks: 19411990

6. Two-Pass Size- Portfolios

Properties of Portfolios Formed on Size and Pre-Ranking : NYSE Stocks Sorted by ME
(Down) then Pre-Ranking (Across): 19411990

7. Subperiod Diagnostics
Subperiod Average Returns on the NYSE Value-Weighted and Equal-Weighted Portfolios and
Average Values of the Intercepts and Slopes for the FM Cross-Sectional Regressions of
Individual Stock Returns on and Size (ln(ME))

VI. Main Result

Thus, when we subdivide size portfolios on the basis of pre-ranking ps, we find a strong
relation between average return and size, but no relation between average return and .

In short, the test in the journal do not support the central prediction of the SLB model, that
the average stock returns are positively related to market .

Banz (1981) document a strong negative relationship between average returns and firm size.
Bhandari (1988) found that the average return is positively related to leverage, and Basu
(1983) found a positive relationship between the average return and E / P. Stattman (1980)
and Rosenberg, Reid, and Lanstein (1985) documents the relationship among the positive
average return and book equity-to-market for US stocks, and Chan, Hamao, and Lakonishok
(1992) found that the BE / ME is also a strong variable to explain the average Japanese stock
returns.

For the 1963-1990 period, size and book to market equity capture the cross sectional
variation in average stock returns associated with size, PE, book-to-market equity, and
leverage.