The Correlations and Volatilities of Stock Returns:

The CAPM beta and the Fama-French factors

Daniel Suh
daniel.suh@mail.wvu.edu

This paper conducts time-series tests on the Capital Asset Pricing Model (CAPM)
and the Fama-French three-factor (FF3) model in the context of market beta
estimation for the cost of equity capital. We find that the market index is by far the
most consistent and powerful systematic risk factor throughout the sample period,
for both large- and micro-cap stocks, in FF3 model as well as CAPM specifications,
and across industry sectors. Most of market betas are statistically significant and
appear to be economically consistent with the systematic risk exposure of individual
stocks. Consistent with the theory, virtually all alpha estimates are statistically zero.
Market volatilities are critical for beta estimates. When the market is highly volatile,
beta estimates breakdown as do correlations of stock returns with the market index.
For small-cap stocks and in a highly volatile market, SMB and HML stabilize the
market beta and improve the statistical explanatory power; for large-cap and in a
relatively stable market, SMB and HML add little to the CAPM beta. Model
diagnostics show that the CAPM and the FF3 model are practically equivalent.
Parameter estimates of the CAPM are generally superior to those of the FF3 model,
except for some small-cap stocks and in a highly volatile market. On the other hand,
statistical explanatory power of the FF3 model is generally superior to that of the
CAPM

1. Introduction

This paper conducts time-series tests on the Capital Asset Pricing Model (CAPM) and the
Fama-French three-factor (FF3) model in the context of market beta estimation for the cost of
equity capital. The CAPM and the FF3 model are among the most widely tested asset pricing
models. However, the literature largely finds that the CAPM falls short in estimating the cost of
capital while the model has been widely taught in business school; the FF3 has been widely used
in academic research while the two factors of the model lack theoretical basis and guide.
Meanwhile, no alternative asset pricing models have substituted for the two models as a tool for
empirical research and application in the estimation of systematic risk and the cost of equity
capital.
Asset pricing models provide estimates for the expected returns of an investment, a critical
factor in the determination of an asset or portfolio value. However, empirical test results of asset
pricing models have been inconclusive. For example, the Capital Asset Pricing Model (CAPM) is
“one of the two or three major contributions of academic research to financial managers during the

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post-war era.” (Jagannathan and Wang, 1996, p.4) However, Roll (1988) finds his test results of
the CAPM “extremely disappointing;” with “all explanatory factors” included, less than 40 percent
of the monthly return volatility in the typical stock can be explained for a sample of the largest
1
firms; explanatory power with daily data is even less. Fama and French (1992) find no
explanatory power of CAPM beta even when the beta is used as a single factor; they put up a sign,
“The CAPM is wanted, dead or alive.” Fama and French (1997) note that imprecise estimates of
risk loadings and factor risk premium “plague industry CE [costs of equity] estimates from any
asset pricing model.” (Italics added) Fama and French (1997) test both the CAPM and the Fama-
French 3-factor (FF3) model and find that the forecast performance of both models is “woefully
imprecise.” 2 Hodrick and Zhang (2001) test a variety of empirical asset pricing models developed
as potential improvements on the CAPM and report that “all of the models fail.” 3
Ferson and
Harvey (1999, p.1325) declared, “Empirical asset pricing is in a state of turmoil.”

Moreover, Roll (1977) critiques that CAPM test is about the mean-variance efficiency of
the market portfolio; therefore if the market portfolio fails to include all risky assets, a true test of
the CAPM is impossible. Multifactor models have been proposed as an alternative to the CAPM.
(Merton, 1973; Ross, 1976) Chen et al. (1986) identify macro variables such as GDP, inflation,
and interest rate term structure as factors. Fama and French (1992, 1993) identify size and book-
to-market as common risk factors. However, Fama and French (1991, p.1594) call multifactor
models “an empiricist’s dream,” because they are “off-the-shelf theories” that can use “any set of
factors that are correlated with returns.” Cochrane (2005, pp.80, 124-126) observe that multifactor
modeling can be “vacuous” because “a regression of anything on anything” can be run; pricing
factors should be robust across samples or different markets and out of samples; since Merton
(1973) and Ross (1976) the standard set of risk factors have changed about every two years. Bodie
et al. (2008) argue that multifactor models with no theory are no more than a description of the
factors that affect security returns. Cochran (2005, p.151) further notes that the identities of
fundamental risk factors are still an unanswered question in finance and that 30 or 40 years of

1
At the same time, Roll (1988) finds some firms with “impressive explanatory power” and suggests an in-
depth study of those firms “for insight.”
2
Forecastability of financial prices is one of the most enduring questions in finance and investment.
(Campbell et al., 1997, p.27) Roll (1988) notes: “The maturity of science is often gauged by its success in
predicting important phenomena… The immaturity of our science [finance] is illustrated by the conspicuous
lack of predictive content about some of its most intensely interesting phenomena, particularly changes in
asset prices.”
3
Hodrick and Zhang (2001) test the CAPM, the consumption CAPM, the conditional CAPM, Campbell’s
(1996) log-linear model, Cochrane’s (1996) production-based model, and Fama-French’s three- and five-
factor models.

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thousands of papers have not moved the debate an inch closer to resolution and a ready solution is
not immediately in sight.

MacKinlay (1995) also observes that multifactor model alone do not entirely explain
deviations from the CAPM, because ex ante CAPM deviations due to missing risk factors are very
difficult to detect empirically. Campbell et al. (1997, p.251) state two dangers with multifactor
models: models may over-fit through data-snooping and captures market inefficiency or investor
irrationality. Campbell et al. further argue that the usefulness of multifactor models will not be
fully known until sufficient new data becomes available to provide an out-of-sample check.
Huberman and Wang (2005, p.1) note: “the large number of factors proposed in the literature and
the variety of statistical or ad hoc procedures to find them indicates that a definite insight on the
topic [the APT] is still missing.” The combined problems of identification of risk factors and
factor structure, parameter stability and consistency have prevented the APT from substituting the
CAPM in use (Van Honre, 2001, p.97) in spite of “hunger for a CAPM replacement.” (Ferson and
Harvey, 1999, p.1326)

Fama and French (1997) test both the CAPM and the FF3 model in terms of estimation of
the cost of equity and find that the “woeful” imprecision comes not only from the imprecise beta
estimates, but also the great uncertain or imprecise estimates of the expected market risk premium;
if historical data is used, the average market risk premium in 1963-94 was 5.16 percent with a
standard error of 2.71 percent, which statistically indicate that true market premium is between
zero and 10 percent.4 Pastor and Stambaugh (1999, PS for short) conduct tests on three sets of
data, a utility firm, a broad cross-section of 1,994 stocks, and 135 utility firms for two overlapping
periods, 1926-1995 and 1963-1995. PS test the CAPM and the FF3 model using Bayesian methods
and find the two models produce practically identical estimates for the cost of equity capital. PS
find: the OLS market beta estimates and the standard deviations of the two models are “fairly”
close; the posterior mean values and standard deviations of the cost of equity of the two models
also are close and “fairly close to the CAPM implied value.” PS conclude that parameter
uncertainty is more important than which model is to be used in the estimation of equity capital. 5

4
In this paper, “market portfolio” refers to the theoretical specification of the market portfolio of the CAPM;
the portfolio is unobservable. “Market index” refers to an observable proxy for market portfolio used in this
paper for empirical tests; this paper uses the Fama-French market index as a proxy for the market portfolio.
In this paper, the market index and the market risk premium (MRP) are equivalent, and interchangeably used.
5
The beta estimates are 0.45 with the CAPM and 0.52 with the FF3 model in the case of a specific utility and
1.01 vs. 0.97 for the broad cross-section stocks. The standard deviations are 0.07 vs. 0.08 for a specific
utility and 0.16 with both models for the broad cross-section stocks. (No explicit comparisons between the
two models for the 135 utility firms are reported) The posterior mean values are 11.25% for the CAPM and

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 Nonetheless, the CAPM may be a useful tool for managers and investors, because the
model as a single market factor model conceptually may work under a wide variety of conditions,
not just for a limited set of portfolios. (Kothari, Shanken, and Sloan, 1995, p.221) Roll (1994) calls
the CAPM “probably the single greatest risk/return innovation.” Campbell et al, (1997, p.183)
observe that the CAPM can be useful for a measure of expected stock returns. Cochrane (2005,
p.152) calls the CAPM “the first, most famous, and (so far) most widely used” model in asset
pricing.

This paper is organized as follows: Section 2 discuss the research focus and summarizes
major findings of this paper. Section 3 lays down test framework and research design that
includes decomposition of the data generating process of the market beta into two elements:
correlations of stock returns with the market index and relative volatilities of stock returns to the
market index. This section also discusses test sample data and the contributions and limitations of
this paper. Section 4 examines the stock return correlations and volatility correlations with the risk
factors, beginning with a discussion of the Fama-French risk factors in the context of multifactor
models of Merton’s (1973) inter-temporal CAPM and Ross (1976) arbitrage pricing model. This
section discusses details of the test results the CAPM and the FF3 model. Section 5 concludes.

2. Research Focus and Major Findings

This paper takes a perspective of a corporate manager who normally makes investment
decisions in an un-diversifiable business. The financial investor can relatively easily and
continuously reallocate investment portfolios for diversification. However, a firm’s business
investment usually is specialized, concentrated, illiquid, non-diversifiable, and irreversible.
Jagannathan and Meier (2002) observe that many investment decisions cannot be reversed without
incurring large costs; managers often cannot propose a project, wait for the reaction of the
shareholders, and then decide whether to undertake it or not. Shleifer and Vishny (1997) discuss
the limit of arbitrage in financial markets where arbitrage is conducted by relatively a small number
of investors who are professional, highly specialized, and undiversified. Xu and Malkiel (2003,
p.2) observe that many investors do not hold diversified portfolios either because of wealth
constraints or by choice. At the same time, managers often use the CAPM to estimate the cost of
equity capital as a function of the market portfolio risk premium and the beta of the model.

11.54% for the FF3 model for a specific utility, 9.61% vs. 9.62% for the broad cross-section. The standard
deviation is 4.02 vs. 4.04 for a specific utility and 9.61 VS. 9.62 for the broad cross-section stocks.
(Graham and Harvey, 2001) This paper focuses on how well the estimated betas reflect the
systematic risk of a firm or an industry sector.6

We conducts time-series tests on the Capital Asset Pricing Model (CAPM) and the Fama-
French three-factor (FF3) model in the context of market beta estimation for the cost of equity
capital in the spirit of Fama and French (1993, 1997) time-series methods. This paper however is
distinct. First, the main focus of this paper is on the data generating process of market risk factor
loading (the market beta). For the purpose, this paper decomposes the beta into two components
and attempts to identify and measure the underlying sources of the beta or factor loadings: stock
return correlations with risk factors and relative return volatilities with the market volatilities, as
𝑪𝒐𝒗 𝒊,𝒎 𝝈𝒊
𝒃𝒊 ≡ ≡ 𝝆𝒊, 𝒎 * . The focus on correlations is consistent with the modern finance
𝑽𝒂𝒓 𝒎 𝝈𝒎

theory, the main foundation of which is the covariance of an asset or a portfolio with systematic
risk factors. The focus on correlations of this paper adds to the literature that is focused mostly on
volatilities at absolute levels, not relative to the market index. Second, tests are conducted on each
individual stock: 309 large-cap stocks in the S&P500 index and 459 micro-cap stocks in the
Russell 2000 Micro-cap stocks, not on portfolios. (In this version, we also include preliminary and
limited results on Fama-French 12 industry portfolios and 25 size/value-sorted portfolios. The
updated version will include full test results on the Fama-French portfoliios)

We attempt to find answers to the following research questions: (1) how stock returns and
volatilities are correlated with the three risk factors (market risk premium, SMB, and HML) and
potentially other factors, (2) whether the CAPM beta provides economically consistent and
statistically significant estimates for the cost of equity of a firm inter-temporally and cross-
sectionally, or whether the CAPM beta provides a quantitatively reasonable and qualitatively useful
reference in the estimation of the cost of equity capital of a firm, and (3) how much the Fama-
French 3-factor model improves the CAPM beta estimates in terms of economic consistency,
statistical explanatory power, and the significance of estimates, or how much the FF3 model adds
useful information to the CAPM for the estimation of the cost of equity for a firm. This paper also
investigates issues related to the above main research questions. Are “Jensen’s alpha” or pricing
7
error statistically zero? Where does the beta come from?8 Does the beta come primarily from the

6
This approach is consistent with Hansen (2005) who argues that a model should be tested based on the
purpose of research, not necessarily on statistical “fit.”
7
Campbell et al. (1997, p.190) calls this property of alpha the principal hypothesis of the model; if all
elements of alpha are zero, then the market index is the tangency portfolio in the mean-variance space.
8
We refer “beta” exclusively to the market index coefficient, while using “loadings” generally for the
coefficients of risk factors including SMB and HML.
correlations (ρi,m) of stock returns with the market index, from the relative return volatilities (σi/σm),
or from other sources as well? Do beta estimates have economically meaningful and statistically
significant non-zero relations with mean returns? How much do the size factor (SMB) and the
value/growth factor (HML) of the FF3 model contribute to the CAPM beta? Are the size and
value/growth estimates economically meaningful and statistically significant? This paper uses
three general criteria in the evaluation and interpretation of test results: consistency with economic
and finance theory, statistical significance and explanatory power, and consistency with economic,
market conditions and systematic risk characteristics of the industry and the firm.

The findings of this paper so far are summarized as follows: The market index is by far
the most consistent and powerful systematic risk factor throughout the sample period, for both
large- and micro-cap stocks, in FF3 model as well as CAPM specifications, and across industry
sectors. Most of market betas for large-cap stocks are statistically significant and appear to be
economically consistent with the systematic risk exposure of individual stocks.9 Micro-cap market
beta estimates have become statistically increasingly significant and also economically consistent;
more than 95% of beta estimates in 2002-2007 are also significant. Consistent with the theory,
virtually all alpha estimates are statistically zero. Market volatilities are critical for beta estimates
(Anderson, et al., 2006, p.793); when the market is highly volatile, beta estimates breakdown as do
correlations of stock returns with the market index. For small-cap stocks and in a highly volatile
market, SMB and HML stabilize the market beta and improve the statistical explanatory power;
for large-cap and in a relatively stable market, SMB and HML add little to the CAPM beta. Model
diagnostics such as serial correlations and heteroskedasticity of residuals, Swartz Bayesian Criteria
(SBC), adjusted R2, Durbin-Watson statistics, etc. show that the CAPM and the FF3 model are
practically identical. All regression statistics including the significance of estimates have steadily
improved over the test period. Parameter estimates of the CAPM are generally superior to those of
the FF3 model, except for some small-cap stocks and in a highly volatile market. On the other
hand, statistical explanatory power of the FF3 model is generally superior to that of the CAPM.

We find that stock returns are most consistently and strongly correlated with the market
index and also with industry factors. The correlations of stock returns with the market and the
industry are more consistent and stronger than with SMB and HML. However, when the market is
highly volatile, correlations of stock returns with the market index generally breakdown. Stock
return correlations with the market index steadily have increased during the test period; micro-cap
stock return correlations more substantially have increased than large-cap stocks. Some large-cap

9
In this paper, we use a 5% of significance level in statistical hypothesis testing.
stocks are often correlated more closely with their own industry than with the market index.
Average correlation coefficients of all large-cap industry sectors are higher than their average
correlation coefficients with the market index. However, industry factors are not un-diversifiable
systematic risks; furthermore, high collinearity of industry factors with the market index prevents
industry factors from being included in statistical regressions. The high correlations of stock
returns with industry factors suggest a limited explanatory power of the market index as systematic
risk factors, although we find the market index is the strongest and most consistent factor among
three risk factors.

We find that unlike large-cap industry all micro-cap stock sectors except energy and
financial sectors are more highly correlated with the market index than with their industry.
However the correlation coefficients are lower than those of large-cap stock returns. Unlike large-
cap stocks often more closely correlated with their own industry factors, correlations of micro-cap
stocks with industry factors are widely dispersed across industry sectors. Unlike large-cap stocks,
most micro-cap stock return correlations with industry sectors are lower than those with the market
index, which implies a high level of diversity and independence of micro-cap stock returns. Two
distinct correlation patterns of micro-cap stocks are noteworthy. First, some micro-cap stocks are
more closely correlated with large-cap stocks in the same industry than with the market index or
with other micro-cap stocks; among them are energy, information technology, and financial
sectors. Second, micro-cap stocks are more likely correlated with financial sector stocks than
large-cap stocks.

Volatility correlations are more stable than return correlations; volatilities generally co-
move. The relative volatilities of individual stocks generally remained more or less steady even
during the information technology bubble-and-burst period, except for the early 1990s when the
relative volatilities were consistently higher. Correlations of an individual stock returns generally
are more important determinants for inter-temporal patterns of stock returns and the market beta
estimates than relative volatilities of stock returns, consistent with the modern finance based on
covariance of returns with the risk factors.

Although the time-series market beta estimates are mostly positive, except during some
portions of a period of high market volatility and deeply negative market returns and for some
micro-cap stocks, and most alpha estimates are statistically zero, a core test for the model
specification, wide ranges of beta and alpha estimates may indicate instability of the coefficients,
model misspecification, or regime switching of beta. The estimated alpha, although statistically
insignificant, often is negatively related with the estimated beta, another indication of model
misspecifications. Market volatilities are critical for beta estimates (Anderson, et al., 2006, p.793);
when the market is highly volatile, beta estimates breakdown as do correlations of stock returns
with the market index. SMB and HML stabilize the market beta during periods of high market
volatilities. The two factors also enhance the statistical power for micro-cap stocks. However, the
SMB and HML add little to the CAPM during a stable market environment or for large-cap stocks
in terms of market beta estimates and statistical significance. We find that the CAPM beta
predominates as a reasonable reference for systematic risk and the cost of equity.

3. Test Framework and Research Design

a. Test Framework
The CAPM directly relates an excess stock returns with the market portfolio premium as
follows:

𝑹𝒊 − 𝑹𝒇 = 𝜷𝒊 * (Rm – 𝑹𝒇) (1)

Ri is the expected returns of stock i, Rf is the risk-free rate, βi is the market risk factor loading, or
the beta, for stock i, and Rm is the expected returns of the market portfolio. Of the three main
components of the CAPM – the risk free rate, the market portfolio risk premium, and the beta - the
beta is the only component a manager could have some control. 10 A manager has no control over
the other two factors; the market determines them. Therefore, beta estimates of a firm would be
more relevant and of interest to a manager. (Pastor and Stambaugh, 1999, p.70)

This paper attempts to examine the factors that determine the market beta under the
CAPM. The empirical test model on realized returns for a single period is specified as follows:

𝒓𝒊 − 𝒓𝒇 = 𝜶𝒊 + 𝒃𝒊 * (rm – 𝒓𝒇) + εi (2)

εi is the residuals and the assumptions of the standard linear regression model should apply if the
model is correct. If the CAPM is a correct model, αi should be statistically zero, an important

10
Tests of this paper indicate that business model exposes a firm to a different level of systematic risks. For
example, firms in the financial sector discussed in this paper may be exposed to different levels of systematic
risks. Investment banking (SIC 62) vs. commercial banking (SIC 602), retail banking vs. corporate banking,
national banking vs. regional or local banking, and banking vs. non-banking such as insurance (SIC 63) may
be exposed to different types and levels of systematic risks. “Health care” sector stocks may also be exposed
to different systematic risks among health services (SIC 80), pharmaceutical firms (SIC 283), health-care
instruments and supplies (SIC 384), etc.
hypothesis of the CAPM tested in this paper. Then on average the realized risk premium of a stock
is explained by the realized market premium and the beta as follows.

𝑬(𝒓𝒊 − 𝒓𝒇) = 𝑬[𝒃𝒊 * (rm – 𝒓𝒇)] (3)

This paper tests for the correlations of the two components inter-temporally as a way to assess the
usefulness of the CAPM to measure the systematic risk level and the required returns of a stock.
The correlation test is an appropriate approach for time-varying betas and returns.

The beta of the CAPM is determined by two components: the correlations (ρi) of a stock
risk premium with the market portfolio risk premium and the relative volatilities (σi/σm) of a stock
risk premium with those of market portfolio risk premium as follows:

𝑪𝒐𝒗 𝒊,𝒎 𝝈𝒊
𝒃𝒊 ≡ ≡ 𝝆𝒊, 𝒎 *
𝑽𝒂𝒓 𝒎 𝝈𝒎

ρ i,m is the correlation of a stock’s expected risk premium with the market portfolio’s expected risk
premium, σi the volatilities of a stock’s expected risk premium, and σm the volatilities of the market
portfolio’s expected risk premium.

This identity defines stock return correlations with a risk factor (𝜌𝑖, 𝑚) and the relations of
𝜎𝑖
stock return volatilities with the risk factor volatilities . This paper examines the dynamics of
𝜎𝑚

these CAPM beta components. First, this paper conducts in-depth investigations into the
covariance and correlations of stock and portfolio returns with three risk factors. The correlations
analyzed in this paper are pair-wise, unconditional, and contemporaneous. The three risk factors
are the market index, a proxy for market risk premium (MRP), and two factors of FF3 model
(SMB, and HML). Individual stocks include four types of stocks: large- and micro-cap stocks,
ultra large stocks (Dow Jones 30), and electric power industry stocks.11 The portfolios include the
Fama-French 12-industry portfolio (FF12 industry portfolio, hereafter), a Fama-French portfolio of
25 sub-portfolios sorted on 5 market-cap sizes and 5 book-to-market categories (FF25 portfolio,
hereafter), and 10 size-sorted and 10 BEME-sorted portfolios. . (This version discusses test
results of 309 large-cap and 459 micro-cap stocks with limited discussion on some preliminary
results on Fama-French portfolios, Dow30, and electric power stocks. The updated version will
include full results)

11
The utility sub-portfolio in the Fama-French 12-industry portfolio is broader and more diverse than the
electric power industry sample data tested in this paper. The former includes electric, natural gas, and water
service firms, the latter is limited to the firms that provide electric power as the main utility service and have
been going through restructuring and deregulation process.
 Second, this paper examines stock return volatilities, relative to the market index.12 In
addition to the relative levels of volatilities, this paper also analyzes the dynamics of the
correlations of volatilities among the risk factors, individual stock returns, and portfolio returns.
Volatility correlations measure how much of a stock’s total volatility is correlated with the risk
factor volatilities. We find that volatilities of stock and portfolio returns are more tightly correlated
than stock or portfolio returns; return volatilities co-move. The co-movement of volatilities leaves
return correlations more significant in the determination of systematic risk and the cost of equity.

Third, the identity defines an inverse relation of the CAPM beta with the market returns
volatility (σm); the more volatile the market portfolio is, the smaller the beta becomes. This inverse
relation holds if the covariance of stock returns with the market remains positive, which our test
shows is true for most stocks and for most of time. If return volatilities of a stock co-move with the
market volatilities, the systematic risk remains high and so does the beta. On the other hand, if a
stock’s return volatility may remain largely unchanged or independent, the relative volatility
becomes smaller, the correlations with the market become weaker and lower, and the beta becomes
smaller. Such stocks of low correlations, volatilities, and beta provide a good diversification
opportunity particularly in a highly volatile market. The high market volatilities during the Internet
bubble and burst in at the turn of the 20th century provide an opportunity to measure the relations
and identify the sources of beta generating process. This paper investigates whether correlations
and volatilities of the information technology (IT) industry and firms shifted higher during the
market volatilities because the industry was the main source for the market volatilities. A related
analysis is to measure the dynamic changes of correlations of defensive industries that are expected
to breakdown in a highly volatile market, resulting in lower beta for those industries and firms.

A notable finding of this paper is that correlations and betas normally breakdown, instead
of tightening, when the market becomes highly volatile. The market index is a weighted average of
individual stock market values. Therefore, some stocks lead the volatility of the market, often
pushing their correlations with the market higher. This paper finds that the correlations of the IT
industry and firms with the market shifted higher and so did the beta estimates during the 2000-
2002 market volatility. On the other hand, the correlations of other industries in general and of
defensive industries in particular broke down and their beta sharply shifted down. The divergent
shifts of the correlations imply that the systematic risk of the IT industry became relatively higher

12
Only the systematic part of volatilities is relevant to the CAPM beta. This paper attempts to estimate
systematic, un-diversifiable volatility or risk directly from the stock return data through regression analysis.
Although statistical techniques to separate total volatilities can be useful, a technique may well introduce its
own measurement errors and is only as useful as its accuracy of the estimates.
pushing its required return up while the stock prices went down. (The preliminary analysis with
2008 data indicates similar patterns with the financial sectors since the credit crisis began in the
second half of 2007 and accelerated in 2008) Meanwhile, the required return of defensive
industries became relatively low while their stock prices moved relatively higher. Regression tests
reveal SMB and HML as important factors during high market volatilities. The two factors also are
more significant for some micro-cap stocks than for large-cap stocks; the former generally are less
correlated with the market than the latter.

Each industry carries economic and investment characteristics distinct enough to provide
an intuitive, economic basis for an analysis of stock return correlations and volatilities and also for
analysis and interpretation on the test results of factor loadings. For example, consumer
staples/nondurables and health care sectors provide essential necessities for daily living. The price
elasticity of demand for the products and services is lower than that of other industries; therefore,
these two industries are “defensive” because relatively less sensitive to business-cycle and market
volatilities than other industries. Therefore, we have economic basis to hypothesize relatively low
volatilities and correlations of these industry sectors with the market volatilities and with the
general economic conditions. We also can hypothesize a low market beta and a lower cost of
equity capital for these industry sectors and firms. For other sectors that are more highly correlated
with the economy and more sensitive to market volatilities, we can hypothesize high beta
estimates. Industry sectors such as consumer durables or discretionary goods, industrials, and trade
generally belong to the second group. Return correlations, volatilities, and market betas among
these industries naturally are more closely correlated than those of defensive industries.

b. Research Design

This paper directly conducts detailed investigations and tests on the CAPM and on the FF3
factors, at firm levels. This approach facilitates analysis of beta generating process, return
correlations, and volatilities at individual stock levels from a perspective of a manager. This
approach adds to the literature that usually bases an asset pricing test on portfolios, not on
individual stocks; those portfolios are not necessarily investable for the investor, nor relevant to a
manager in the estimation of the cost of capital. 13 Tests on portfolios, often formed more for
statistical reasons (for example, 5-year intervals regardless of economic and market conditions)
13
A constant change in the composition and the total number of stocks of such portfolios make the use of
such portfolios as benchmarks difficult. Bailey et al. (2007) list properties of a benchmark portfolio for
investment. Two of the properties are: the identities and weights of securities or factor exposures
constituting the benchmark are clearly defined in advance; the benchmark is investable so as to forgo active
management and simply hold the benchmark. (CFA Program Curriculum, Level III , Vol.6, 2009)
than on economic basis, make economic analysis difficult. Grouping of individual assets smoothes
out noises of individual data series, which can be informative and relevant to the financial investor.
While a portfolio test approach reduces noise and enhances statistical power, the approach leaves
out “tremendous” amount of economic information embedded in noise and is of limited value to a
manager in investment decision-making. (Cochrane, 2005, p.135) Berk (2000) shows that the
explanatory power of the model will always be smaller within a group or a portfolio than in the
whole sample. Berk argues: by picking enough groups, one can destroy the within-group
explanatory power of an economically correct asset pricing model and show that the true asset
pricing model has no explanatory power within each group.

In his comment on Fazzari, Hubbard, and Petersen (1988, p. 200), James M. Poterba calls
their explicit modeling of heterogeneity of the firm a “new ground breaking.” In contrast, CAPM
beta research often is conducted on an aggregated portfolio basis. Firm-level market returns are
aggregated across divergent firms and industries into a portfolio by factors such as market value-
based firm size, book-to-market value ratios, or the estimated beta. Lo and MacKinlay (1990)
argue that a grouping based on the factor that determines the variable of interest amounts to “data
snooping.” To test asymmetric response of beta to news, Cho and Engle (1999) use individual firm
data rather than aggregated data because the latter smooth out asymmetric responses of beta to
news. Moreover, a corporate manager would be primarily interested in beta estimates for the firm
and other individual competitors. A disaggregated analysis helps more directly investigate the
causal relationships at a firm or industry level, which provides more relevant information to
corporate managers.

Some recent research papers explore the economic origin of systematic risks at
disaggregated levels and find different or even opposite results from analyses based on aggregated
levels. In their investigation into whether or not a beta increases with bad news and decreases with
good news, Cho and Engle (1999) test individual Blue Chip stocks to model conditional co-
variances and beta. They find that asymmetric effects of news are partially explained by changes
in expected returns through a change in betas. Cho and Engle argue that stock price aggregation of
monthly data in the research work of Braun, Nelson, and Sunier (BNS, 1995) resulted in a loss of
cross sectional variation and lead to weak results of asymmetric effects of news. Cho and Engle
use daily returns of the individual stocks to allow the separation of market shocks and idiosyncratic
shocks. BNS (1995) recognize that they may have lost much of the cross-sectional variation in
betas due to aggregation of data to industry levels and missed asymmetric responses of the
conditional betas of individual firms. They suggest individual firm-level analysis by separating
stock returns into market, industry, and firm specific components and checking the effects on
conditional betas in the context of a model of financial structure.

Disaggregated approach allows for a focused analysis on the cause-and-effect relations of

factors. (Engle, 2003) Inspired by the finding of Campbell and Mei (1993) that systematic risk
arises, not because of correlation between a company’s cash flow and the market return, but
primarily because of common variation in expected returns, Cornell (1999) conducts an in-depth
test on a specific firm using quarterly financial data of the firm. Cornell finds that the firm’s
information confirms the theory of Campbell and Mei and other firms generally practice the theory
too. Campbell, Polk, and Vuolteenaho (2005) and Vuolteenaho (2003) explore business
fundamentals such as cash flows, profitability (return on assets), and debt-asset ratio at firm-levels,
and find that those fundamentals have a “dominant” influence on cross-sectional pattern of
systematic risk in the stock market. Campbell, Lettau, Malkiel, and Xu (2001) use a
“disaggregated” approach to study the volatility of common stocks at the market, industry, and firm
levels.14 They find “strong” evidence of a positive deterministic trend in idiosyncratic firm-level
volatility, but no similar trend in industry and market volatility. They also find that the correlations
among individual stock returns have declined over the past few decades, and firm-level volatility
accounts for the greatest share of total firm volatility on average and for the greatest share of the
movements over time in total firm volatility. .

This paper has its limitations and biases by design, which should to be taken into account
in test design and the interpretation of test results. The test samples initially were limited to stocks
that have an uninterrupted 20-year history for 1988-2007. To minimize daily non-trading or zero
return data of ultra micro-cap stocks, this paper sampled micro-cap stocks from the Russell 2000
micro-cap index which contains stocks in the 2,001-4,000th market cap as of August 2008, rather

14
Claiming that the aggregate market return is only one component of the return to an individual stock and
that industry-level and idiosyncratic firm-level shocks are also important components of individual stock
returns, Campbell, Lettau, Malkiel, and Xu (2001) list the reasons for a disaggregated approach. (1) Many
investors have large holdings of individual stocks; they may fail to diversify for various reasons and are
affected by shifts in industry-level and idiosyncratic volatilities as much as by shifts in market volatilities. (2)
Notwithstanding conventional wisdom that a well-diversified portfolio of 20 to 30 stocks practically
eliminates all idiosyncratic volatility, the adequacy of this approximation depends on the level of
idiosyncratic volatility in the stocks making up the portfolio. (3) Arbitrageurs face risk in idiosyncratic
return volatility, not aggregated market volatility, when they exploit mispricing of an individual stock. (4)
Firm-level volatility is important in event studies. (5) The price of an option on an individual stock depends
on the total volatility of the stock return. Goyal and Santa-Clara (2003) list limited diversification due to
transaction costs and taxes, employee compensation plans, and private information.
than from the smallest-cap stocks of a universe of 7,600 stocks.15 Of the Russell 2000 Micro-cap
stocks, any stocks with more than an average of 25 percent of non-trading data for the period or
with heavy concentrations of non-trading in the 1980s and early 1990s are also excluded. We
conduct tests on 307 large-cap stocks out of the S&P500 index and 465 “micro-cap” stocks in the
Russell 2000 Microcap index in August 2008. The test samples, while serving the purpose of this
paper, may well be survivorship-biased. The micro-cap data has an average of approximately 25
percent of non-trading data in the first half of the 1990s, which dropped to approximately 12
percent in the second half of the 1990s and further down below five percent in the new
Millennium. The temporal patterns of non-trading data in our test is quite similar to those of the
non-trading data in the universe of more than 7,600 stocks, which indicates that the micro-cap
stocks in our sample are more biased toward relatively liquid stocks among micro-cap stocks. 16
Therefore, survivorship bias may not be so serious a problem in our test data.
Non-trading is a major source of autocorrelation and weak correlations of stock returns
with the market index. (Campbell et al. 1997, Sections 3.1 and 3.4; Kadlec and Patterson, 1999)
The tested large-cap stocks are a subsample of S&P500 index as of July 2008. Study on more than
3,600 ultra micro-cap stocks could offer valuable insight on the dynamics, even findings
fundamentally different.17 Study on other large- and micro-cap stocks excluded from the test
sample, if not the entire universe of stocks, could offer valuable additional insight on the dynamics
of stock returns. 18
This paper conducts statistical regressions and daily stock return analysis on each stock and
each year. This approach implicitly follows a general assumption of temporal IID of stock returns

15
We initially attempted to select micro-cap stocks out of the universe of 7,609 stocks collected from the
CRSP. We initially excluded more than 600 stocks that lack SIC codes or identification information
necessary for industry classifications. We then attempted to use the smallest 2,000 micro-cap stocks out of
the universe of more than 7,600 stocks. However, those stocks have extensive zero or missing return data,
often stretched over several months. Therefore, we selected micro-cap data from the Russell 2000 Microcap
Index, which contains stocks ranking of 2,000 through 4,000 in market capitalization.
16
The list of public firms is in constant ebb and flow. Of the universe of 7,609 firms that existed at the end
of 2007, only 1,759 firms or less than a quarter of firms have a full history since 1991. That means that
more than three quarters of firms have less than 20 years of history as public firms. During the same period,
6,049 firms out of 7,807 firms which had existed as public firms before 1988, which means more than three
quarters of firms had dropped out of the list during the period.
17
At the end of 2007, the CRSP database contained 7,611 common stocks.
18
Ultra micro-cap stocks may not be so practically relevant to financial investors because the market value of
ultra micro-cap is so miniscule in the market. Correlations of ultra micro-cap stocks with the market
generally are lower than those of micro-cap stocks tested as shown in this paper. Therefore, application of
the CAPM or the FF3 model to ultra micro-cap stock may prove be not so useful or meaningful to a manager
of such firms.
(e.g., Campbell et al., 1997, p.190) but fails to consider potential temporal and cross-sectional
dependence of stock returns.

c. Data and Risk Factors

We conduct tests on the daily returns of individual firm stocks, collected from the Center
of Research for Security Prices (CRSP) database. The stock returns are the total stock returns,
adjusted for dividends. We use the daily Fama-French market risk premium (MRP) data as a proxy
for the market portfolio returns. Daily data, a higher frequency than weekly or monthly, provides
more observations with relatively far less industry- or firm-specific events and subsequent stock
price reactions. (Roll, 1988; Chan and Lakonishok, 1992; Fama and French, 1988, p. 246) A main
focus of this paper on correlations requires high frequency data. (Engle, 2009; Shanken 1987)
High frequency data is particularly useful for the purpose of this paper. For example, in a highly
volatile market, a week or a month hardly passed by without significant industry events or news
and the subsequent reactions of stock prices. Same was true during the electric power industry
restructuring process that included the industry crisis and the subsequent industry–wide corporate
restructuring. Fama and French (1988) test autocorrelations of stock prices for subsample periods.
They find that autocorrelation is weak for daily and weekly holding periods but stronger for long-
horizon returns. Our test with monthly data not reported in this paper confirms persistent serial
correlations. Andersen, et al. (2001, pp.48-50) characterizes high-frequency return data as follows:
as the frequency increases, the expected mean is asymptotically zero, or the impact of drift
vanishes effectively eliminating the mean; the expected variance of returns is asymptotically true
variance and the variance of returns is asymptotically zero or free of measurement error. Bollerslev
and Zhang (2003) argue that high-frequency data more accurately measure volatility with a
reference to new findings through the use of high-frequency data.

This paper tests eight groups of individual stocks and portfolios as listed in Table 1. The
first two groups are two market-cap groups of individual stocks: large S&P500 and micro-cap
firms. Analysis and statistical tests are conducted on each of the individual stocks. The results are
groups into industry sectors for model diagnostics and economic interpretations: consumer staples,
consumer discretionary/durable goods, industrials, energy, wholesale/retail trade business, health
care, information technology, and financials. We only select common stocks that provide full
history for the entire test period with also SIC information. Therefore, 307 firms (60%) in the
S&P500 index are included in our test. Out of 2,000 Russell Micro-cap Index firms, 459 firms
(approximately 25%) are included in the test. The micro-cap stocks are in the ranking of 2,000-
 19
4,000 in market value. This method of sample selection and grouping has its own sampling
bias.20 However, such a focused, disaggregated analysis of a specific industry helps utilize
conditioning information on the market, the industry, and the firms. Such analysis also helps
identify the sources of the changes in the beta estimates both ex ante and ex post and relate the
changes in the beta estimates not only with the underlying economic, industry and market factors,
but also with a firm’s business model and investment/financing strategy. (Fama and French, 2008b;
Roll, 1988; Hays and Upton, 1986) (Needs better-defined structure and criteria in the use of
extraneous information)

The next four groups are the Fama-French 12-inddustry portfolio (FF12 portfolio), a Fama-
French portfolio composed of 25 sub-portfolios (FF25 portfolio), sorted on five market
capitalization sizes and then on five book-to-market values (BE/ME), and 10 size-sorted and 10
BEME-sorted portfolios. An objective of analysis and test on these portfolios is to identify the
risk characteristics of portfolios and the reasons Fama-French (1992) find no or little relation of
the CAPM beta with stock returns. The last two groups are the electric power industry stocks and
the Dow Jones 30 stocks. The electric power industry has been going through a restructuring and
deregulation process since the 1990s. A main objective to analyze and test the specific industry is
to test how the beta shifts its regime as the industry and the firms become exposed to systematic
risk. The tests would also provide additional information on the usefulness of the CAPM beta to
the manager as a reference for the cost of equity. A main objective to analyze and test the DJ30
stocks is to gain insight into the unique characteristics of return correlations and volatility
correlations of ultra large-cap stocks and contrast with small-cap and other stocks. We compile a
list of 51 firms for regression analysis from two sources: the “U.S. Shareholder-owned Electric
Utilities” of the Edison Electric Institute (EEI), an electric industry association, and the “Utility
Parent Companies, Investor-owned Utilities, and Diversified Energy and Unregulated Companies”
of Fitch Ratings, a credit rating agency. We exclude firms whose main business is natural gas
transmission and delivery with electric power supply business as a minor sector. The selected
firms represent a virtual universe of the investor-owned electric power firms which trade common
stocks in the financial markets; the main business of the selected firms before 1998 was regulated

19
We initially examined the smallest 2,000 micro-stocks out of the universe of over 7,600 common stocks
that existed at the end of 2007. However, the micro-sized stocks have a large number of zero or missing
return values (for example, more than 20% of total observations on average for the smallest 2,000 stocks).
Instead we select firms from 2,000 stocks in the Russell Microcap Index, which still has approximately zero
or missing values for 13% of total observations. Therefore, our micro-cap stocks are somewhere in an upper
midrange of more than 7,000 U.S. stocks.
20
Constantly mindful of potential selection bias, we attempt to consider the probable impacts of the bias on
the test results and interpretations.
 electricity, not natural gas, utility. 21 Our tests cover three different subsamples of a recent period:
during full regulation (before 1998), during transition to competition (1998-2002), and the ongoing
transformation of the industry (2003 and after).

4. Systematic Risk and Factor Loadings

a. Fama-French Risk Factors and Portfolios

(Check the accuracy of this section)

Fama-French (1992) add multi-factors to the CAPM market portfolio, size (SMB) and
value/growth (HML) factors, both based on market capitalization, the most prominent anomalies
(Brennan and Xia, 2001) The two factors can be zero-cost investment arbitrage portfolios: long on
small, but short on large market-capitalization stocks (SMB) and long on high, but short on low
book-to-market capitalization stocks (HML). Fama-French find that the SMB and HML improve
the statistical fit of their test while the CAPM beta does not explain cross-sectional returns even
when used by itself. The model is similar with the style investment portfolios of some investment
managers, classified by market capitalization-based size or “value” stocks.

The Fama-French model has controversial issues. First, the two factors lack a solid
theoretical and economic foundation. (Black, 1993) While recognizing that SMB and HML are
“empirically” determined “mimicking portfolio,” Fama and French (1993, p.4, 8) maintain that the
two factors are “related to economic fundamentals,” such as earnings and cash flows. Perold
(2004, p.22) argues that the value and size factors are not explicitly about risk, but proxies for risk
at best; size per se cannot be a risk factor that affects expected returns because small firms would
simply combine to form large firms. The first problem leads to the second problem: a lack of
quantitative criteria to evaluate the model results. Under the CAPM, for example, the market
portfolio beta should be unity, which means that an investment portfolio which closely follows the
market portfolio should be close to one. Under the FF3 model, no such clear criteria are defined
for the size and value factors. Except for statistical criteria, no consistent economic and finance
theory-based interpretations and assessments of parameter estimates are feasible. Lewellen (2006)
makes “disconcerting” observations that the great variety of factor models which seem to work
have very little in common with each other. Lewellen suggests four “prescriptions,” the first two
of which are to expand the set of test assets to include other portfolios and to impose theoretical

21
The firms in our test supply approximately three quarters of electricity in the U.S.; the remaining quarter is
generated by federal power agencies, municipal utilities, and electric cooperatives, none of which is investor-
owned or issues exchange market-traded stocks.
restrictions on the estimates. The third issue is statistical and logical. Van Horne (2001, p.75)
argues that when both dependent and independent variables contain a common element, the
statistical explanatory power improves; regression tests of the portfolios sorted on size and book-
to-market value on SMB and HML also formed by size and book-to-market value would produce
statistically significant results than otherwise. Fourth, the FF3 model has failed the acid test as an
economic model: forecasting the cost of equity. Fama and French’s (1997) find the forecasting
performance of the FF3 model “woefully imprecise.”
Fama and French (FF, 2008a) discusses the sources of size premium and value premium.22
FF find that migration of stocks between portfolios is “almost entirely” the source of high returns
for small-cap stocks and for high book-to-market value stocks. Migration often takes place with
small growth (SG) stocks that have realized “extreme” excess returns ranging 34% to 165% per
year, or with large value (LV) stocks that realized “strong” negative returns of -24% to -53%.
Small growth stocks that have become already large in a small portfolio make a big push to the
portfolio return before they migrate. Large value stocks that have become small in market size and
higher in book-to-market ratio pulls down the portfolio return, albeit the magnitude of the impact is
smaller than that of SG stocks because the size of LV stocks has become smaller in the portfolio.
FF also find the same pattern of return impacts of migration into different “style” or book-to-
market portfolio. An SG stock often migrates to a low book-to-market portfolio, lifting high the
returns of the current high book-to-market portfolio. The same pattern applies in reverse to an LV
stock that migrates to a high book-to-market portfolio, pulling down the low book-to-market
portfolio returns.

The findings of FF (2008a) appear to be consistent with intuition and economic logic. By
design, the size and book-to-market portfolio returns implicitly assume perfect market timing for
small-cap portfolios but wrong market timing for large-cap portfolios at investment reallocation.
The annual resorting of the FF portfolio based on the market value and book-to-market ratio is
equivalent to selling small growth stocks with high returns, or selling high for the current
portfolios; on the other hand, large value stocks are sold low at a loss or low returns.23 By design,
Fama-French’s large stock portfolio returns are lower than small stock returns; high book-to-
market stock portfolio returns are higher than low book-to-market stock portfolio returns. The FF
findings may make trivial the argument that attributes the “size premium” to risky distress of some
small-cap firms, as FF (2008a) find the market size of small stocks of “Bad Delist” less than one

22
Fama and French (2007) uses VMG (value minus growth) for value premium instead of HML.
23
Graham (1949, pp. 26, 27) recommends that the successful value investor use pricing well below intrinsic
value, not timing, methods in investment decisions.
percent of small portfolios. FF also find that small stocks more often disappear in mergers than big
stocks; acquisitions by another firm occurs more often among value stocks than growth stocks;
“Good Delists” for small stocks are higher in percent for small stocks than large stocks. FF is
surprised that book equity more likely goes negative for growth stocks, particularly small growth
stocks than for stocks in the matching neutral or value portfolios. FF (2008a) observe that some
firms in the growth portfolios are “actually distressed” with high price-to-book ratios because their
book value has fallen even more than their market value.

The FF (2008a) findings appear more consistent with a fundamental concept of the value
stock investing than the common definitions in the literature. Graham (1949) defines value
investing as investing in a stock, the price of which is well below the unknown intrinsic value.
Textbook concept of value investing is also based on intrinsic value rather than book value. Reilly
et al. (2009, pp.454-456,492) define value stocks as stocks undervalued other than earnings growth
potential and growth stocks as stocks expected to realize above-average risk-adjusted rate of return;
any undervalued stocks are growth stocks. Both value and growth investing is rational because
both stocks are undervalued compared to intrinsic value and are expected to realize risk-adjusted
excess returns. This investing concept is not based on historical book value, but intrinsic valuation
which is fundamental in finance. This investing concept is based on the expected, not realized,
future rate of return, consistent with finance theory. This intrinsic value-based investing is relative,
risk-adjusted valuation, not based on absolute levels of returns nor risk-unadjusted book value.24
On the other hand, the literature defines a stock as a value stock whose price is relatively lower
than the book value. Tobin’s q is based on replacement cost, not book value which rarely would be
the same as the intrinsic value or represent replacement cost. Book value is an accumulation of
historical accounting entries, which require adjustment for inflation, intangible value of a firm, off-
balance-sheet items, and other accounting distortions to estimate intrinsic or “fair” value. Ross et
al. (2006, p.24) even argue that the market value of an asset has nothing to do with accounting
book value. Fama and French (2007) document that the expected profitability, book-to-market
ratios, and returns of value and growth stocks “converge.” If a stock with low BE/ME is often
overvalued compared to its intrinsic value, rather than undervalued, the realized “growth” stock
returns naturally are lower than “value” stock returns. (Add references)

b. Stock Return Correlations and Volatilities

24
One may assume that book value may have become a reasonable proxy for intrinsic value. When a firm is
acquired or merged by other firm, the recent GAAP-mandated purchase method requires to record “fair”
value on the balance sheet of the acquiring firm. The increasing GAAP requirement of “fair” value-based
accounting report also may help update balance sheet closer to intrinsic value.
 a. Return Correlations
This section examines unconditional, pair-wise, and contemporaneous correlations of stock
returns, not conditional, multivariate, and inter-temporal. However, return correlations of
individual stocks with the market index and aggregated results on industry levels provide rich
information and insight into the expected beta estimates. The regression tests of the CAPM in
Section 5 largely reflect the return correlation characteristics to be discussed in this subsection and
provide a basis to assess how the FF3 model adjusts the correlations in a multivariate setting with
SMB and HML. Table 2 shows that stock returns are most consistently and strongly correlated
with the market index (MRP) and with the industry. The correlations of stock returns with the
market and the industry are more consistent and stronger than with SMB and HML. The weak
correlations of individual stock returns with SMB and HML may be a main factor for the weak,
unstable estimates of the two risk loadings as discussed later. (Expand further with more details on
SMB and HML)
For large cap stocks, the correlation coefficients with MRP and with industry factors are
more stable and significant than other correlations. The correlations of large-cap stock returns with
the market index are higher than those of micro-cap stock returns. Engle (2009, p.8) suggests that
small stock returns often move dramatically with large idiosyncratic components, while large-cap
stocks are better diversified and the returns move often with macroeconomic conditions; therefore,
volatilities of large-cap stock returns should be less than those of small-cap stocks and correlations
should be higher. However, higher volatilities and lower correlations of small-cap stocks leave
their relative market beta undetermined without more detailed information of the stocks.
(Tentative: The correlations with the market index of the FF portfolio are more homogeneous
across different portfolios)
There are two noteworthy shifts in the correlations. First, micro-cap stock return
correlations with MRP significantly increased to a level of 0.3 and higher in the New Millennium
from a level of 0.1 in the early 1990s. Figure 1 also shows that the correlations of both large- and
micro-cap stocks with the market index steadily and significantly increased during the sample
period. (add tables) The average large-cap industry stock correlations with the market index
moved from 30%-50% to 50%-70% during the sample period, while the micro-cap stocks shifted
dramatically from 5%-15% to 45%-55%. Where are the sources for the increased return
correlations of micro-cap stocks with MRP from? The fast increase in the correlations of micro-
cap stock returns with the market index may be in part related with the substantial reductions in
non-trading of micro-cap stocks of the test sample in particular and also of the stock market in
general, as suggested by Figure 2. No single day of non-trading is found in the large-cap stock
sample data of 307 firms. With the introduction of the NASDAQ in the early 1970s, daily non-
trading of the entire universe of stocks dramatically increased and reached a high of 45.9 percent in
1977. Beginning 1992, however, non-trading has steadily and fast declined to below 4 percent in
2007. (Figure 2-1) The increased availability of low-cost trading may have made arbitrage trading
easier for small-cap stocks, and contributed to decreases in non-trading. (Perold, 2004, p.19) Daily
non-trading of 465 micro-cap sample stocks also steadily have declined in the sample period.
(Figure 2-2)
Second, return correlations of both large- and micro-cap stocks with SMB also shifted into
a positive zone at 0.25 and higher. Nonetheless, correlations among individual large-cap stocks
are stronger than those among individual micro-cap stocks.25 (Further related questions: What
factors contributed to the substantial and steady drop in non-trading? Is the decimalization of
stock quotes that began on January 29, 2001 a contributing factor? Why have large-cap stock
correlations also increased, albeit at a slower pace than micro-cap stocks? Will a test with data of
the 1990s and after substantially change the original results and conclusions of FF (1992, 1993)?
How serious is non-synchronous data for more than 3,400 stocks smaller than the micro-cap stocks
used in this test? What made SMB turned positive and significant in 2004-2007?)
Table 2 and Figure 1 show that the correlations of individual stocks with the market index
broke down during a highly volatile market downturn (1999-2001). However, the correlations of
the information technology (IT) sector increased during the period. The average large-cap industry
stock correlations excluding the IT sector dropped from 40%-60% in 1998 to 10%-35% in 2000
before rebounding to 40%-70% in 2002. The average micro-cap industry stock correlations
excluding the IT sector also dropped from 20%-30% in 1998 to 10%-15% in 1999 before
rebounding to 15%-30% in 2000. (Why drop in 1999, not in 2000? Why a faster recovery for
micro-cap stocks?) As discussed above, the beta formula prescribes a drop in beta in a highly
volatile market, unless the covariance of a stock return with the market index also changes
proportionally or higher. The divergent shifts in correlations between the IT sector and the other
sectors during the high market volatility in general are expected, because the IT sector was the
main driver for the market boom-and-bust. The breakdown of correlations is universal at varying
degrees across individual stocks of different market-cap stocks, across aggregated industry
portfolios such as the FF 12-industry portfolio, and across most of FF 25 portfolios. The

25
This paper considers correlations of stock returns with returns of equity assets or portfolio s only.
Potentially important correlations of stock returns with non-equity financial assets or with non-financial
market variables may exist.
breakdown of correlations provides room for SMB and HML to stabilize the market beta in a
highly volatile market. (Tentative, SMB and HML appear over-adjust for large-cap stocks and
during a relatively stable market. FF25 portfolios shows relatively constant correlations or less
drops in a volatile market because of a wide size range of the IT firms constitute every portfolio?)
Next to the market index, individual stock returns are most correlated with own industry
returns and other related industries. Engle (2009, p.4, 8) observes that the highest correlations are
between stocks in the same industry and the correlations are higher within asset classes; stocks in
the same industry have highly correlated earnings news and therefore are more highly correlated
with each other than with stocks in different industries. Roll (1992) finds that industrial structure is
a significant factor for international return differences and a country’s market index can be
analogous to a particular industry sector bets. In his seminal paper on industry factors in stock
prices, King (1966) finds most covariance outside the within-industry negative, but no negative
covariance in the within-industry. King concludes: almost all of the large positive residual
covariance can be attributed to factors corresponding to industry groups and any large negative
covariance is of the between-industry variety; the market, not the industry, generally is the
principal source of stock price non-stationarity. However, high multicollinearity of industry
returns with the market index prevents industry factors included together with the market index in
regressions. An economic question is whether some portions of industry factors are non-
diversifiable. As we discuss below, stock returns are strongly correlated with industry, often even
more strongly than with the market index or other factors examined in this paper.
As found in Table 3, large- and micro-cap stocks shows distinct patterns of stock return
correlations with the market index and industry returns. Table 3-1 shows the highest correlations
of large- and micro-cap stock returns, summarized by industry sectors. Large-cap stocks are most
closely correlated either with the market index or with their own industry. More than half of
discretionary, health, industrials, and information technology sector stock returns are most highly
correlated with the market index. On the other hand, more than half of energy, financials,
materials, and consumer staples sector stock returns are more closely correlated with their own
industries than with the market index.
Micro-cap stocks show interesting correlations, which may represent unique risk
characteristics of micro-cap stocks. The correlation characteristics may offer insight into how the
expected systematic risk of a micro-cap stock is determined by a confluence of factors. First,
seemingly counterintuitive, more than a half of stocks (between 49% of financials and 100% of
durables) of all industry sectors are most closely correlated with the market index; energy sector is
the only exception with only 22% of the sector stocks are most closely correlated with the market
index. The seemingly counterintuitive, high correlations of micro-cap stock returns with the
market index need to be tempered with the correlation coefficient levels in Table 3-2. The
correlation coefficients of micro-cap stock returns with the market index range between 0.22 and
0.31, compared to large-cap stock return correlations between 0.31 and 0.54. These low correlation
coefficients suggest that micro-cap stock returns are more independent of systematic risk than
large-cap stocks.
Second, the remaining stocks are widely dispersed across large-cap and micro-cap stock
returns and across different industry groups, making the left half of Tables 3-1 and 3-2 crowded, in
contrasted with the neat two lines of large-cap correlations on the right half of the table: the
horizontal line with MRP and the diagonal line at the lower half of the large-cap matrix. Unlike
large-cap stocks, the correlation coefficients of micro-cap stock returns with industry factors are
even lower than the correlations with the market index, and are widely dispersed across industry
sectors. Wide dispersion of correlations across industry sectors with no such clear or solid patterns
as in large-cap stocks, estimation of systematic risk and beta for micro-cap stocks would be less
reliable and predictable than large-cap stocks.
Third, some micro-cap stocks are more closely correlated with large-cap counterparties,
rather than with micro-cap stocks, in the same industry. For example, almost a half of micro-cap
energy stock returns are most closely correlated with large-cap counterparties. The correlation
pattern may represent the unique correlation characteristics of the energy industry in general: less
correlated with the market index and highly correlated within the industry with high idiosyncratic
volatilities. Financial and IT sectors show similar patterns of correlations with large-cap stocks of
lesser degree. Financial and IT sectors may have become so integrated within each industry that
large-cap stocks lead the industry stock returns. (Check the accuracy)
Fourth, relatively higher portions of stocks are closely correlated with micro-cap financial
sectors; energy sectors, consumer staples, and industrials are among them. These sectors are
relatively capital-intensive, and local or regional sources of financing may be a critical factor of
business performance. (Check the accuracy)
The two supplementary figures below Table 3 show additional noteworthy correlations.
The average correlation coefficients with the industry and with the market of both large-cap and
micro-cap stocks moved virtually in parallel throughout the sample period, with the industry
correlations about 10 percentage points below the market correlations. The correlations of stock
returns with the industry remain largely steady even when the market is highly volatile, for
example, in 1999-2001, consistent with King’s (1966) findings as discussed above. This stability
may further enforce the consistency and power of the market index as the risk factor for stock
returns. This stability is in contrast with stock return correlations with SMB and HML, which are
mostly weak and unstable, often switching signs between negative and positive with no economic
bases clearly identified. The financials, IT, and industrial sectors are more closely correlated with
the market than energy, consumer staples, and health care sectors. (Include tables for the figures)
The correlation characteristics are reflected in the estimated betas to be discussed later. (Expand
with more details on the FF12, FF25 portfolio, DJ30, and the electric power industry)

[Tentative: We also find some unique correlations characteristics in stocks, industries, and
portfolios. (Add tables) The utility stock portfolio of the FF 12-industry portfolio show much
lower correlations with the market index than the within-industry correlations over the period of
1963-2008. The telecommunications sector, which used to be weakly correlated with the market
index as regulated utility stocks until the early 1990s, became increasingly correlated with the
market index since the mid-1990s. The telecommunications industry deregulation, the advancing
telecommunication technology, the high competition may have resulted in a regime-switching of
the industry return correlations.26 A similar pattern is observed in the financial sectors, also due
probably to the deregulation of the financial sectors 27 Most small-cap FF25 portfolios show higher
correlations within the same size sub-portfolios than with the market index; four of the largest-cap
portfolios (S1) are highly correlated with the market index, except for the high BE/ME (H5) ]

The correlations of industry sectors with the market index appear largely intuitive and
consistent with the economics of industry as shown in Figure 1. For example, the financial and IT
sectors show higher correlations in large-cap stocks, while the consumer staples and health care
sectors show lower correlations. ( Add a table by industry) In micro-cap stocks, the consumer
durables and IT sectors are most highly correlated with the market index; energy, health, and
consumer staples are least correlated. Roll (1992) also finds that industry characteristics in
international markets are consistent with intuition and economics in most cases, although he finds
some “disquieting” puzzling correlations. (Investigate into industry characteristics of return
correlations. Why unique characteristics of each industry, particularly the financial and energy
sectors?)

26
The Telecommunications Act of 1996 deregulated the telecommunications industry and opened the
industry to competition. Since then, the traditional, regulated, land-line telephone industry had gone through
a substantial restructuring and consolidations
27
The Financial Services Modernization Act of 1999 tore down the walls set up by the Glass-Steagall Act of
1933 between banking, securities, and insurance services and opened the industry to competition and a wave
of consolidations.
 b. Return Volatilities

This section examines unconditional, total volatilities of stock returns, not conditional and
systematic part of total volatilities. However, the volatilities of stock returns provide rich
information and insight into the expected systematic risk of a stock or portfolio. Table 4 and the
accompanying figures show the industry aggregation of individual stock volatilities. Several
observations can be made that may be useful for the expected beta and systematic risk. First,
return volatilities of stocks generally follow or co-move with the market volatilities. Table 5
documents the volatilities of the market index, SMB, and HML and volatility correlations. The
volatilities are highly correlated at correlation coefficients of 0.644 to 0.834. (Panel A. and the
accompanying figure) The high correlations are compared with very low return correlations.
(Panel A. and the accompanying figure) Co-movement of return volatilities appear to be dominant.
During the test period of 1991-2007, the volatilities of the individual stock returns generally
followed the market volatilities. (Table 4 and accompanying Figures A-1 and B-1) (Also show
correlations of the two sets of volatilities) The co-movement is confirmed by the largely stable
volatilities of stock returns relative to the market index. (Figures A-2 and B-2) The co-movement
of return volatilities suggests that return correlations are a more relevant factor for systematic risk
and market beta than volatilities. A caveat is that, for some individual stock returns, volatilities
may be a more significant factor than return correlations. As we discuss in more detail later in the
updated version, for electric power industry stocks, volatilities appear to be an important measure
of systematic risk because individual stock returns in the industry are tightly correlated within the
industry; the same may be true for the energy sector which show strong within-industry
correlations. Therefore, a significant portion of systematic risk of a firm in the two industries
appears to come more from volatilities that are sensitive to the market than from return correlations
with the market. (Is this observation contrary to Campbell et al., 2001 who find volatilities of
individual stocks increased while the market volatilities remained practically unchanged? What
are the reasons for the high relative volatilities during the first part of the of1990s? Can the
relatively stable relationship of stock return volatilities among individual stocks attributed to the
general increase in liquidity or trading technology in addition to plausible survivorship bias of the
test sample?)

Second, volatilities of micro-cap stocks are higher than those of large-cap stocks,
indicating that, as discussed above, the systematic portion of total volatilities is more relevant to the
expected beta of micro-cap stocks than large-cap stocks. Engle (2009, p.8) suggests that small
stock returns often move dramatically with large idiosyncratic components, while large-cap stocks
are better diversified and the returns move often with macroeconomic conditions; therefore,
volatilities of large-cap stock returns should be less than those of small-cap stocks and correlations
should be higher. A caveat is that systematic part of volatility, not total idiosyncratic volatility,
should be relevant for systematic risk and the cost of equity; the next section on statistical
regression test results provides some measure.

Third, the volatilities of three sectors of micro-cap stock– energy, information technology,
and health sectors - appear to have moderated and converged to other sectors during the New
Millennium. The moderation or convergence of volatilities may be due in part to the maturation of
micro-cap stocks of the three industries in the test sample. Figure 2-3 shows that, after having
dramatically increased in the 1980s and 1990s, the number of NASDAQ stocks dropped
significantly beginning the late 1990s. (Will the three sector volatilities remain low? Verify this
interpretation with the SIC and return volatilities of the three sector stocks)

Fourth, the volatility levels appear to be consistent with economic characteristics of the
industries. For large-cap stocks, information technology and energy sectors are most volatile,
while consumer staples and health sectors are most stable. For micro-cap stocks, information
technology and energy sectors also are among the most volatile and consumer staples sector is most
stable. Unlike large-cap stocks, however, health sector among most volatile in the 1990s have
converged to other low volatile sectors. This may reflect a diverse composition of the sector that
also includes biotech and medical equipment sectors, as discussed above. (Verify the interpretation
with the SIC and return volatilities of the large- and micro-cap health firms)

5. Regression Test of Risk Factor Loadings

Most CAPM market beta estimates are statistically significant. The statistical significance
and explanatory power of the CAPM improved steadily and substantially over the sample period.
Consistent with the CAPM, virtually all alpha estimates of large- and micro-cap stocks are
insignificant. The SMB and HML add explanatory power to the CAPM, particularly in highly
volatile market conditions and for some micro-cap stocks. However, the two risk factor loadings
are often unstable and alternate signs with no clear patterns, nor discernable economic consistency.
SMB and HML add little to the CAPM or to statistical diagnostics for large-cap stocks or in a
relatively stable market. Both the CAPM and FF3 model are practically equivalent in statistical
diagnostics. The CAPM beta overall predominates as a reference for systematic risk.
i. A. Estimates of Risk Factor Loadings28

We find several major findings with statistical tests. First, model specification tests show
that the market index is most consistent and powerful factor among three risk factors. Table 6-1
shows that for large-cap stocks 93% of market beta estimates are significant by itself or in
combination with SMB, HML, or both. For micro-cap stocks, 73% of estimates are significant.
On the other hand, SMB is significant for less than 33% of large-cap stock estimates and 53% of
micro-cap stock estimates in combination with MRP or HML. HML is significant for 40% of
large-cap stock estimates and 25% of micro-cap stock estimates in combination of MRP or SMB.
For 20% of micro-cap estimates, none of three factors is significant. As discussed below, statistical
significance substantially improved and 95% of all micro-cap estimates have become significant by
2007. F-test for omitted variables also confirms a dominating power of the market index compared
to other two factors. Table 6-2 shows that the market index is significant for an average of 95% of
large-cap regressions of joint variables, SMB and HML; since 2002, the market index is significant
practically for all regressions. On the other hand, SMB and HML jointly are significant for an
average of 55% of large-cap regressions of the market index. For micro-cap stocks, the market
index is more powerful, contributing to SMB and HML for an average of 73% of regressions,
compared to an average contribution of 55% to the market index regressions from SMB and HML.

Second, the CAPM and the FF3 model are practically equivalent in statistical significance
of estimates and diagnostics. Table 7-1 shows that the significance of both the market beta and
alpha estimates are practically identical between the two models. As expected, alpha estimates are
insignificant for 96.2% of large-cap CAPM regressions and for 96.6% of FF3 regressions. For
micro-cap stocks, alpha estimates are insignificant for 95.9% of CAPM regressions and for 96.7%
of FF3 regressions. SMB and HML are much less significant than the market index. SMB and
HML loadings are significant for a quarter to 40% of regressions. On the other hand, the adjusted
R2 of the FF3 are superior to the CAPM, most of differences come from the lowest R2 category of
less than 0.10.

The CAPM and the FF3 models virtually mirror each other in terms of the significance and
variations of time-series alpha estimates as shown in Table 7-2. However, the CAPM beta
estimates appear to be more statistically significant than the FF3 beta loadings for most of the test
period as shown in Table 7-3. Conspicuous exceptions are during highly volatile market

28
For brevity, unless specifically referred to a model, size, etc., each sentence applies generally to both
models, all groups of stocks, and all categories.
conditions: in 2000-01 for large-cap stocks and in 1999-2000 for micro-cap stocks. The CAPM
beta estimates persistently more significant that the FF3 estimates, particularly since 2002 for
large-cap stocks and since 2004 for micro-cap stocks. the FF3 beta estimates are relatively more
stable for significant beta estimates than the CAPM. But the insignificant FF3 beta estimates are
much more unstable than the CAPM.

Third, over the sample period, beta estimates have become increasingly more significant;
virtually all beta estimates of large-cap stocks became statistically significant in 2002-2007. (Table
7-4) The statistical significance of micro-cap stock beta estimates substantially improved during
period; 94% of CAPM beta estimates became significant in 2006 and 2007 after a steady
improvement from 56% in the beginning year of the sample period. Additional statistical
diagnostic further confirm the improvement of statistical estimates and diagnostics. The increased
return correlations with the market index and the significant reduction in non-trading data during
the test period may be the main sources for the dramatic improvement of statistical significance of
market beta estimates.

Fourth, the CAPM appears to be superior for stocks that are highly correlated with the
market index, a natural relation between dependent and independent variables for a single factor
model. (Table 7-5) For large-cap IT highly correlated with the market as discussed before, the
CAPM estimates are less insignificant. For energy sector less correlated with the market than other
industry sectors in general as discussed above, the FF3 model estimates are less insignificant. On
the other hand, the CAPM estimates of health care sector of both large- and micro-cap stocks also
are less insignificant, which may suggest for further refinement of the sector classification as
discussed above.

Fifth, in highly volatile market conditions, market beta estimates became relatively less
significant in 1999-2001 for large-cap stocks and in 1999 and 2000 for micro-cap stocks. (Figure
1) The low significance of beta estimates is consistent with breakdown of return correlations in a
highly volatile market (Table 2)

In spite of significant statistical estimates, the beta estimates are highly time-varying as
discussed earlier. Tables 8-1 shows a summary of beta estimates aggregated at six industry levels.
Several noteworthy observations are as follows: First, the beta estimates of the FF3 largely
remained stable at approximately 1.1 during the sample period, whereas the CAPM showed high
variations. The large-cap market beta estimates of the CAPM and the FF3 model diverged
significantly in 1999-2001, consistent with the sharp drop in return correlations during the period
as discussed earlier. The divergence of micro-cap beta estimates between the two models is large
throughout the sample period. Equality test of beta estimates confirm the divergence of large-cap
estimates between the two models during the high market volatility in 1997-2001 (Tables 8-2 and
8-3) Micro-cap estimates are statistically non-equal throughout the test period. At industry level,
temporal estimates are mostly non-equal probably due mainly to time-varying estimates in addition
to the impacts of the model specifications. Exceptions are health and consumer staples sectors of
large-cap stocks and health and IT sectors of micro-cap stocks.
Second, the CAPM estimates that had been lower than those of the FF3 in the 1990s
became even higher than those of large-cap stocks. The sharp increase in the CAPM beta of micro-
cap stocks is consistent with the sharp increase in return correlations as discussed earlier.
However, the high variations of micro-cap beta estimates of the CAPM may indicate instability of
the estimates and misspecification of the model, although no significant autocorrelations are
statistically detected and virtually all alpha estimates are statistically insignificant. The CAPM, a
single market factor model, may overestimate a stock return correlation in the beta estimate.
Nonetheless, the statistical significance of beta estimates steadily improved as discussed above;
variations of the estimates also steadily became smaller particularly for micro-cap stocks (Table 7-
4)
While stabilizing the market beta during highly volatile market conditions, the SMB and
HML estimates are highly unstable, often insignificant, and switch signs with no clear patterns
detected or economic basis identified. (Tables 8-4 and 8-5) However, SMB estimates are
relatively more significant for micro-cap stocks.
Additional statistical diagnostics further confirm the equivalence of the CAPM and the FF3
model. Table 9 shows that the Swartz Bayesian Criteria (SBC) of the two models are highly close.
Residual tests for serial correlations and heteroskedasticity show (Table 10) that the two models are
almost identical, although the CAPM has slightly less serial correlations and heteroskedasticity
than the FF3 model.

Presented in the rest of this section without accompanying numeric tables are additional
statistics consistent with the above-discussed findings. The t-statistics of beta estimates also
significantly improved during the sample period with more dramatic improvement of micro-cap
stock estimates. The average t-statistics of large-cap stocks, aggregated into industry sectors,
improved from 5.0 to 12.0, micro-cap stocks substantially from 2.0 to 9.0. Consistent with the
higher return correlations of large-cap stock returns with the market index than those of micro-cap
stocks, large-cap beta estimates are higher and statistically more significant than micro-cap stocks.
Not only are virtually all alpha estimates of large- and micro-cap stocks insignificant, but also the
variations of the estimates have steadily narrowed throughout the sample period.

The statistical explanatory power also improved steadily throughout the sample period.
The adjusted R2 of large-cap stocks improved from an average of approximately 0.12 to 0.37 and
micro-cap stocks dramatically from an average of approximately 0.03 to 0.27. (The R2 of large-cap
stocks of both models dropped 2004-2006 while those of micro-cap stock kept going up. The
reasons are unknown) The average Durbin-Watson statistics of large-cap stocks remained between
2.0 and 2.1 while those of micro-cap stocks steadily improved from an average of approximately
2.3 to below 2.1 in 2005-2007. The FF3 model has a relatively higher statistical explanatory power
than the CAPM, while the statistical significance of beta estimate of the CAPM is higher and alpha
estimates are more insignificant than the FF3 model.
The above statistical results, combined with the correlations of stock returns discussed
earlier, suggest that (1) the market index is the most powerful of the three risk factors, (2) SMB and
HML remedy the misspecification problem of the CAPM during high market volatility and for
micro-cap stocks, and (3) the FF3 model may suffer from some multi-collinear relations among the
three factors. Therefore, in a highly volatile market or for a firm or industry highly volatile or
weakly correlated with the market index, the CAPM may overestimate the correlations of stock
returns in the market beta estimates while the FF3 model may over-counteract it with SMB and
HML. (Check the accuracy of the above interpretations)

The overestimation cases of the CAPM may be found during the high market volatility in
1999-2001 and also in the micro-cap beta estimates for 2004-2007 that are higher than large-cap.
(Table 8-1) The over-counteraction cases may be found in the FF3 beta estimates that are fairly
stable within a bound throughout the sample period. A good case of over-counteraction of the FF3
model may be found in the large-cap IT firm beta estimates, which dropped sharply from 1.65 in
1995 to 0.28 in 1996. During the highly volatile Internet boom and bust in 1996-2002, the FF3
model estimates remained between 1.4 and 1.9, well below the CAPM beta estimates. Throughout
the period, the FF3 model estimates remained below the highest beta estimate of 1.67 in 2002.

5. Concluding Summary

We have found not only useful insight into the beta generating process but also many more
questions to be addressed as a result of the findings. Most new questions are primarily about
“why?” and “how?” about the findings. The updated version will keep pursuing the “why?’ and
“how?” questions, as well as conducting time-series tests on Fama-French size- and value-sorted
portfolios, ultra-large stocks, and a specific industry, the electric power industry firms. The
updated version will include 2008 data to test the robustness of our findings and interpretations on
the current credit crisis and market volatilities. Our time-series tests follow some of the research
approaches of Fama-French (1993 and 1997). Our tests on a variety of stocks and portfolios follow
the “prescriptions” of Lewellen (2006). Following are summary of findings on beta generating
process.

The market index is by far the most consistent and powerful among three risk factors
throughout the test period, for both large- and micro-cap stocks, and across industry sectors. The
alpha values of both models are statistically zero as expected in most cases. The market index beta
provides economically reasonable estimates for market risk, cross-sectionally (by industry) and
inter-temporally. Individual stocks are more highly and consistently correlated with their own
industry or with other industry sectors than with SMB or HML.

The test results of the CAPM and the FF3 models generally are equivalent in terms of
market portfolio beta estimates, explanatory power of the models, and statistical significance of
estimates. Such a pattern is more pronounced for large firms and during a period of relatively
stability.

Market volatility is important. When the market is relatively stable, the market index often
dominates in terms of explanatory power, parameter estimates, and statistical significance. SMB
and HML add little to the CAPM when the market is relatively stable or for a firm or an industry
sector that is closely correlated with the market. However, during high market volatilities, for
example in 2000-2002, the beta estimates of the CAPM drop sharply while those of the FF3 model
remain largely stable. The statistical power of the CAPM is particularly low for 1998-2001 when
the market was unusually volatile during the heights of the Internet bubble and the burst. When the
market is highly volatile, the FF3 model is superior in explanatory power.

SMB and HML often are statistically insignificant. Furthermore, the signs of the two
factor loadings are usually mixed and the estimates are unstable. The lack of theoretical basis and
quantitative criteria to assess the estimates as well as the statistical insignificance and instability of
estimates of the two factors undermine the two factors as systematic risk factors. This observation
is particularly relevant for large firms and for a period of stable market conditions, where the FF3
model adds little to the CAPM.
 The correlations of micro-cap stock returns with the market index returns are lower than
those of large-cap stocks throughout the test period. However, it is notable that the correlations of
micro-cap stocks have steadily increased over time, except briefly in 1999. Also notable is that the
steady increases have taken place across all industry sectors. The correlations of large stocks have
remained largely stable, although they had uptrend in recent years. The conspicuous upward trend
of correlations of micro-cap stock returns may due in part to our sampling bias by design, because
we selected stocks that have remained as a public firm throughout the test period. A micro-cap
firm’s correlations with the market normally may increase after having grown as a public firm for
15 years or longer since as late as 1993. The steady and substantial reduction of non-trading of
micro-cap stocks since the early 1990s may be a major reason for the increased correlations.

The volatilities of micro-cap stocks are consistently higher than those of large stocks over
time and across industry sectors. Volatilities of both groups of stocks have generally become
reduced, except for the period of 2000-2002. The relative reductions between the two groups have
remained just about constant: the volatilities of micro-cap stocks are approximately 50 percent
higher than those of large stocks. The relative stability in relative volatilities suggests that
correlations are a more significant risk determinant consistent with finance theory.
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 Table 1
Test sample Data Series

The current version of this paper discusses test results on micro-cap and large-cap stocks. The
updated version will have full discussions on the other stock and portfolio series as well.

Samples (Daily data) # of stocks or

portfolios

Micro-cap stocks (1993-2007) 459

Large-cap (S&P) stocks (1991-2007) 307*

Fama-French 25 size/value sorted portfolios (1963-2008) 25

Fama-French 12 industry portfolios (1963-2008) 12

Fama-French 10-size and 10-BEME portfolios (1963-2008) 20

Dow-Jones 30 (1991-2008) 30

Electric power industry firms (1991-2008) 51**

NOTE: Large-cap stocks include Dow-Jones 30 stocks. Large-cap stocks include some electric
power industry firms.
 Table 2
Stock Return Correlations with Risk Factors and Industry Returns

This table shows average annual correlation coefficients of individual stock returns with MRP (Market risk
premium), SMB, HML, and industry factors in large- and micro-cap stocks.

Large-cap stocks Micro-cap stocks

MRP Industry SMB HML MRP industry SMB HML
1991 0.427 0.217 -0.150 -0.181 0.1153 0.0216 0.0051 -0.0315
1992 0.337 0.160 -0.038 -0.149 0.1053 0.0169 0.0432 -0.0460
1993 0.292 0.157 -0.080 -0.112 0.0951 0.0239 0.0283 -0.0444
1994 0.347 0.165 -0.080 -0.149 0.1309 0.0388 0.0346 -0.0702
1995 0.279 0.151 -0.078 -0.122 0.1011 0.0252 0.0348 -0.0646
1996 0.376 0.210 -0.131 -0.236 0.1241 0.0355 0.0339 -0.1063
1997 0.482 0.292 -0.287 -0.355 0.1626 0.0586 -0.0412 -0.1287
1998 0.482 0.315 -0.104 -0.365 0.1657 0.0714 0.0521 -0.1459
1999 0.306 0.225 -0.192 -0.131 0.0961 0.0601 -0.0138 -0.0411
2000 0.267 0.293 -0.124 -0.102 0.1778 0.0723 0.0859 -0.1508
2001 0.407 0.372 -0.022 -0.203 0.2387 0.1094 0.0920 -0.1715
2002 0.579 0.466 -0.216 -0.270 0.2916 0.1584 -0.0119 -0.1252
2003 0.550 0.420 -0.059 -0.209 0.2767 0.1647 0.0701 -0.1085
2004 0.484 0.356 0.259 -0.068 0.2936 0.1991 0.2509 -0.0742
2005 0.482 0.346 0.251 -0.053 0.2951 0.1914 0.2465 -0.0712
2006 0.465 0.326 0.293 -0.160 0.3220 0.2122 0.2876 -0.1567
2007 0.595 0.436 0.099 0.026 0.3472 0.2799 0.2048 0.0281
Average 0.421 0.289 -0.039 -0.167 0.1964 0.1023 0.0825 -0.0887
Standard 0.105 0.103 0.169 0.101 0.091 0.082 0.101 0.054
deviation

0.80
Large-cap correlations with risk factors and industry
0.60
0.40 HML

0.20 industry
0.00 MRP
2001

2004

2007
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000

2002
2003

2005
2006

-0.20 SMB
-0.40
-0.60

0.40
Micro-cap correlations with risk factors and industry
0.30
HML
0.20
industry
0.10
MRP
0.00
SMB
1996
1997

2004
2005
1991
1992
1993
1994
1995

1998
1999
2000
2001
2002
2003

2006
2007

-0.10
-0.20
 Table 3-1

Stock Return Correlations with the market index and industry factors

This matrix shows how the stocks across columns are correlated with stocks across rows. Each column adds up to 100%.

Micro-cap Stocks Large-cap Stocks

Durables Energy Financial Health Industrial IT Staples Trade Discretionary Energy Financial Health Industrial IT Materials Staples
Durables 0.8% 2.5%
Energy 4.3%
Financials 17.4% 27.1% 7.4% 3.8% 11.8% 3.6% 9.4% 5.0%
Health 5.0% 1.3% 2.9%
Industrials 4.2% 5.0% 9.5% 3.8% 1.8%
IT 4.3% 0.8% 2.5% 3.2% 2.6%
Staples 4.3% 1.3% 1.8%
Trades 1.7% 2.1% 1.8%
MRP 100.0% 21.7% 49.2% 75.0% 68.4% 76.9% 76.5% 80.4% 67.3% 10.7% 26.4% 51.6% 74.5% 58.5% 35.0% 18.8%
SMB 1.7% 1.3%
Discretionar 0.8% 2.1% 2.9% 5.4% 30.9% 3.1%
Energy 47.8% 2.5% 1.1% 1.3% 89.3% 5.0%
Financials 11.9% 2.5% 2.9% 1.8% 64.2% 3.2% 3.1%
Health 2.5% 1.1% 45.2%
Industrials 1.1% 1.3% 2.9% 1.8% 25.5%
IT 2.5% 2.1% 6.4% 41.5%
Materials 1.7% 2.1% 55.0%
Staples 1.8% 1.8% 75.0%
 Table 3-2

Stock Return Correlation Coefficients with the market index and industry factors

Micro-cap Stocks Large-cap Stocks

Durables Energy Financial Health Industrial IT Staples Trade Discretionary Energy Financial Health Industrial IT Materials Staples
Durables 0.089 0.170
Energy 0.081
Financials 0.119 0.227 0.177 0.164 0.126 0.129 0.426 0.252
Health 0.203 0.081 0.088
Industrials 0.174 0.130 0.134 0.133 0.248
IT 0.110 0.082 0.121 0.115 0.101
Staples 0.103 0.078 0.079
Trades 0.111 0.108 0.239
MRP 0.313 0.242 0.257 0.216 0.301 0.291 0.266 0.272 0.432 0.308 0.543 0.363 0.462 0.466 0.412 0.319
SMB 0.143 0.092
Discretionar 0.086 0.266 0.263 0.308 0.489 0.515
Energy 0.226 0.107 0.106 0.100 0.581 0.388
Financials 0.321 0.089 0.195 0.089 0.583 0.389 0.313
Health 0.111 0.097 0.457
Industrials 0.197 0.173 0.072 0.143 0.530
IT 0.174 0.486 0.458 0.629
Materials 0.425 0.463 0.568
Staples 0.391 0.515 0.427
Average 0.313 0.194 0.247 0.198 0.267 0.274 0.237 0.261 0.451 0.552 0.558 0.406 0.480 0.533 0.489 0.406
 Table 4
Return Volatilities (daily returns)

Panel A: Large-cap stocks

year Discretionary energy fin health industrial it materials staples

1991 0.023 0.024 0.019 0.022 0.020 0.030 0.018 0.017
1992 0.021 0.026 0.016 0.021 0.017 0.029 0.016 0.016
1993 0.019 0.022 0.016 0.023 0.016 0.028 0.015 0.017
1994 0.018 0.020 0.014 0.018 0.016 0.026 0.015 0.015
1995 0.018 0.017 0.013 0.018 0.015 0.027 0.015 0.014
1996 0.019 0.019 0.014 0.021 0.016 0.030 0.014 0.015
1997 0.019 0.022 0.018 0.023 0.018 0.032 0.016 0.019
1998 0.025 0.031 0.024 0.027 0.023 0.034 0.021 0.021
1999 0.025 0.031 0.023 0.027 0.024 0.036 0.024 0.022
2000 0.031 0.031 0.028 0.034 0.028 0.049 0.027 0.028
2001 0.026 0.028 0.020 0.025 0.024 0.045 0.022 0.019
2002 0.026 0.030 0.022 0.028 0.025 0.041 0.024 0.020
2003 0.019 0.018 0.016 0.020 0.018 0.026 0.017 0.014
2004 0.015 0.018 0.012 0.017 0.014 0.022 0.015 0.012
2005 0.016 0.020 0.012 0.014 0.013 0.018 0.014 0.012
2006 0.016 0.021 0.011 0.015 0.015 0.019 0.015 0.011
2007 0.019 0.019 0.020 0.015 0.017 0.018 0.017 0.013
Average 0.021 0.023 0.018 0.022 0.019 0.030 0.018 0.017

0.060
A-1: Volatilities of large-cap stocks Discretionary
0.050 (daily returns) energy
0.040
fin
0.030
health
0.020
industrial
0.010
it
0.000
materials
1993

1995

1997

2002

2004
1991
1992

1994

1996

1998
1999
2000
2001

2003

2005
2006
2007

staples

7.00
A-2: Relative volatilities of large-cap stock returns
Discretionary
6.00
energy
5.00
4.00 fin

3.00 health
2.00 industrial
1.00 it
0.00 materials
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007

staples
Table 4 (cont’d)

Panel B: Micro-cap stocks

year durables energy fin health industrials it staples trade

1993 0.027 0.047 0.028 0.041 0.026 0.037 0.032 0.027
1994 0.024 0.040 0.026 0.043 0.025 0.036 0.029 0.026
1995 0.022 0.040 0.023 0.045 0.024 0.036 0.029 0.024
1996 0.024 0.039 0.022 0.041 0.024 0.037 0.028 0.027
1997 0.022 0.036 0.022 0.040 0.023 0.033 0.027 0.026
1998 0.028 0.041 0.027 0.047 0.027 0.039 0.036 0.033
1999 0.028 0.043 0.025 0.046 0.029 0.039 0.029 0.033
2000 0.034 0.040 0.030 0.059 0.032 0.052 0.033 0.038
2001 0.034 0.033 0.025 0.049 0.029 0.048 0.030 0.034
2002 0.032 0.034 0.023 0.044 0.029 0.044 0.029 0.032
2003 0.026 0.028 0.019 0.034 0.024 0.032 0.023 0.027
2004 0.022 0.028 0.017 0.033 0.022 0.027 0.023 0.024
2005 0.022 0.028 0.017 0.029 0.022 0.024 0.021 0.023
2006 0.023 0.026 0.017 0.026 0.023 0.025 0.020 0.022
2007 0.028 0.026 0.024 0.026 0.026 0.025 0.025 0.027
Average 0.026 0.035 0.023 0.040 0.026 0.036 0.028 0.028

0.070
B-1: Volatilities of micro-cap stocks
0.060 durables
(daily returns)
0.050 energy

0.040 fin

0.030 health

0.020 industrials

0.010 it

0.000 staples
2000
2001
2002
2003
2004
2005
1993
1994
1995
1996
1997
1998
1999

2006
2007

trade

12.00
B-2: Relative volatilities of micr-cap stock returns
durables
10.00
energy
8.00
fin
6.00
health
4.00 industrials
2.00 it
0.00 staples
2007
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006

trade
 Table 5
Co-movement of Return Volatilities

std_MRP std_SMB std_HML

AV_MRP AV_SMB AV_HML

std_MRP 1.000 0.834 0.707

AV_MRP 1.000 0.073 -0.418

std_SMB 0.834 1.000 0.644

AV_SMB 0.073 1.000 0.089

std_HML 0.707 0.644 1.000

AV_HML -0.418 0.089 1.000

.030
.0024

.0020
.025
.0016
.020 .0012

.0008
.015
.0004

.010 .0000

-.0004
.005
-.0008

.000 -.0012
88 90 92 94 96 98 00 02 04 06 08
-.0016
88 90 92 94 96 98 00 02 04 06 08
STDEV_MRP
STDEV_SMB
STDEV_HML AV_MRP AV_SMB AV_HML
 Table 6-1
Model Specification
(Significant factor loadings)

Specification Market SMB HML Large-cap Micro-cap

Index estimates estimates
1 x 1,954 37.2% 1,273 17.7%
2 x x 925 17.6% 2,288 31.8%
3 x x 1,258 23.9% 451 6.3%
4 x x x 720 13.7% 1,242 17.3%
5 x x 41 0.8% 23 0.3%
6 x 42 0.8% 250 3.5%
7 x 57 1.1% 69 1.0%
8 No variables are significant 79 1.5% 1,452 20.2%
Subtotal 5,076 96.6% 7,048 98.1%
Other specs 177 3.4% 137 1.9%
TOTAL 5,253 100.0% 7,185 100.0%
 Table 6-2
Tests for omitted variables (F-tests)

a. Contributions of the Market Index (MRP) to SMB and HML

Large-cap Micro-cap
Contribute No Total % Contribute No Total %
Contribution Contribution
1991 304 5 309 98.4%
1992 288 21 309 93.2%
1993 284 25 309 91.9% 238 239 477 49.9%
1994 302 7 309 97.7% 282 195 477 59.1%
1995 260 49 309 84.1% 243 234 477 50.9%
1996 269 40 309 87.1% 257 220 477 53.9%
1997 290 19 309 93.9% 354 123 477 74.2%
1998 296 13 309 95.8% 380 97 477 79.7%
1999 286 23 309 92.6% 324 153 477 67.9%
2000 282 27 309 91.3% 300 177 477 62.9%
2001 304 5 309 98.4% 399 78 477 83.6%
2002 306 3 309 99.0% 420 57 477 88.1%
2003 308 1 309 99.7% 423 54 477 88.7%
2004 307 2 309 99.4% 412 65 477 86.4%
2005 309 309 100.0% 404 73 477 84.7%
2006 307 2 309 99.4% 403 74 477 84.5%
2007 309 309 100.0% 452 25 477 94.8%
Total 5011 242 5253 95.4% 5291 1864 7155 73.9%

b. Joint Contributions of SMB and HML to MRP

Large-cap Micro-cap
Contribute No Total % Contribute No Total %
Contribution Contribution
1991 139 170 309 45.0%
1992 155 154 309 50.2%
1993 167 142 309 54.0% 142 335 477 29.8%
1994 123 186 309 39.8% 171 306 477 35.8%
1995 155 154 309 50.2% 148 329 477 31.0%
1996 167 142 309 54.0% 192 285 477 40.3%
1997 181 128 309 58.6% 245 232 477 51.4%
1998 183 126 309 59.2% 329 148 477 69.0%
1999 214 95 309 69.3% 227 250 477 47.6%
2000 267 42 309 86.4% 189 288 477 39.6%
2001 242 67 309 78.3% 308 169 477 64.6%
2002 165 144 309 53.4% 331 146 477 69.4%
2003 132 177 309 42.7% 324 153 477 67.9%
2004 172 137 309 55.7% 298 179 477 62.5%
2005 154 155 309 49.8% 329 148 477 69.0%
2006 155 154 309 50.2% 331 146 477 69.4%
2007 140 169 309 45.3% 370 107 477 77.6%
Total 2911 2342 5253 55.4% 3934 3221 7155 55.0%
 Table 7-1
Statistical Significance of Risk Factor Loadings (the CAPM vs. the FF3 Model)

Large Firms (309 firms) Micro-cap Stocks (479 firms)

CAPM FF3 CAPM FF3
Total # of estimates 5,253 5,253 7,185 7,185
Alpha 5,053 96.2% 5,076 96.6% 6,894 95.9% 6,948 96.7%
(insignificant)
Market Betas 5,069 96.5% 5,014 95.5% 5,336 74.3% 5,322 74.1%
(significant)
SMB loadings 1,797 34.2% 2,436 33.9%
significant
HML loadings 2,172 41.3% 1,750 24.4%
significant
Adj R2 1390 26.5% 951 18.1% 4,365 60.8% 3,836 53.4%
<0.10
<0.20 1416 27.0% 1458 27.8% 1,239 17.2% 1,296 18.0%
<0.30 1119 21.3% 1194 22.7% 844 11.7% 948 13.2%
<0.40 700 13.3% 816 15.5% 463 6.4% 608 8.5%
<0.50 384 7.3% 499 9.5% 213 3.0% 330 4.6%
>0.50 244 4.6% 335 6.4% 61 0.8% 167 2.3%
Total 5,253 100.0% 5,253 100.0% 7,185 100.0% 7,185 100.0%
2
Max R 0.753 0.752 0.711 0.724
 Table 7-2
Alpha estimates and variations

# of Estimates Variations of Estimates

Large-cap Micro-cap Large-cap Micro-cap

Year CAPM FF CAPM FF CAPM FF CAPM FF

Insignificant 1993 302 302 459 472 0.0012 0.0010 0.0017 0.0018
1994 302 303 467 468 0.0009 0.0009 0.0015 0.0015
1995 302 295 457 457 0.0010 0.0010 0.0017 0.0017
1996 304 301 467 469 0.0010 0.0009 0.0015 0.0014
1997 301 299 464 469 0.0009 0.0010 0.0015 0.0015
1998 299 300 460 463 0.0014 0.0013 0.0017 0.0017
1999 291 299 461 460 0.0015 0.0016 0.0020 0.0019
2000 297 302 460 466 0.0015 0.0016 0.0022 0.0022
2001 293 295 450 458 0.0012 0.0013 0.0017 0.0018
2002 304 304 465 466 0.0009 0.0009 0.0014 0.0014
2003 304 305 455 461 0.0009 0.0008 0.0012 0.0013
2004 304 304 461 466 0.0008 0.0007 0.0013 0.0013
2005 299 303 459 463 0.0008 0.0007 0.0012 0.0012
2006 308 295 465 453 0.0007 0.0008 0.0010 0.0010
2007 266 283 444 457 0.0009 0.0009 0.0013 0.0012
Total 4476 4490 6894 6948 0.0011 0.0011 0.0016 0.0016
Significant 1993 7 7 20 7 0.0019 0.0020 0.0034 0.0027
1994 7 6 12 11 0.0027 0.0024 0.0029 0.0027
1995 7 14 22 22 0.0028 0.0024 0.0024 0.0032
1996 5 8 12 10 0.0005 0.0018 0.0015 0.0030
1997 8 10 15 10 0.0010 0.0026 0.0011 0.0026
1998 10 9 19 16 0.0032 0.0032 0.0036 0.0043
1999 18 10 18 19 0.0036 0.0022 0.0050 0.0049
2000 12 7 19 13 0.0012 0.0028 0.0038 0.0053
2001 16 14 29 21 0.0012 0.0011 0.0023 0.0023
2002 5 5 14 13 0.0003 0.0020 0.0022 0.0022
2003 5 4 24 18 0.0011 0.0004 0.0023 0.0035
2004 5 5 18 13 0.0020 0.0021 0.0024 0.0020
2005 10 6 20 16 0.0021 0.0023 0.0038 0.0035
2006 1 14 14 26 0.0000 0.0022 0.0032 0.0031
2007 43 26 35 22 0.0024 0.0024 0.0031 0.0034
Total 159 145 291 237 0.0028 0.0027 0.0039 0.0038
 Table 7-3
Variations of Beta estimates

Large Micro-cap

Year capm FF capm FF

Insignificant 1993 0.244 0.350 0.437 0.516
1994 0.151 0.165 0.399 0.455
1995 0.235 0.306 0.423 0.580
1996 0.152 0.478 0.296 0.578
1997 0.000 0.291 0.183 0.354
1998 0.000 0.148 0.269 0.358
1999 0.144 0.258 0.195 0.488
2000 0.097 0.223 0.153 0.264
2001 0.092 0.050 0.165 0.244
2002 0.000 0.122 0.147 0.209
2003 0.000 0.000 0.223 0.285
2004 0.125 0.342 0.324
2005 0.223 0.309
2006 0.059 0.172 0.264
2007 0.168 0.151
Total 0.192 0.336 0.321 0.448
Significant 1993 0.567 0.583 0.588 0.619
1994 0.474 0.466 0.498 0.501
1995 0.713 0.541 0.684 0.655
1996 0.420 0.368 0.504 0.531
1997 0.390 0.353 0.387 0.464
1998 0.353 0.409 0.395 0.438
1999 0.455 0.493 0.385 0.539
2000 0.554 0.379 0.605 0.547
2001 0.594 0.452 0.601 0.541
2002 0.421 0.469 0.437 0.490
2003 0.397 0.385 0.437 0.453
2004 0.405 0.301 0.545 0.372
2005 0.360 0.321 0.461 0.357
2006 0.463 0.399 0.537 0.426
2007 0.312 0.303 0.354 0.326
Total 0.476 0.427 0.560 0.486
 Table 7-4
Temporal changes in significant Beta estimates

Insignificant beta estimates Significant beta

CAPM FF3 CAPM FF3 CAPM FF3
Large-cap 184 239 3.5% 4.5% 5069 5014
1991 8 5 2.6% 1.6% 301 304
1992 21 21 6.8% 6.8% 288 288
1993 17 25 5.5% 8.1% 292 284
1994 7 7 2.3% 2.3% 302 302
1995 21 48 6.8% 15.5% 288 261
1996 5 39 1.6% 12.6% 304 270
1997 1 18 0.3% 5.8% 308 291
1998 1 13 0.3% 4.2% 308 296
1999 20 23 6.5% 7.4% 289 286
2000 57 27 18.4% 8.7% 252 282
2001 24 5 7.8% 1.6% 285 304
2002 1 3 0.3% 1.0% 308 306
2003 1 1 0.3% 0.3% 308 308
2004 2 0.6% 309 307
2005 309 309
2006 2 0.6% 309 307
2007 309 309
Micro- 1849 1863 25.7% 25.9% 5336 5322
cap
1993 266 238 55.5% 49.7% 213 241
1994 207 196 43.2% 40.9% 272 283
1995 261 233 54.5% 48.6% 218 246
1996 195 220 40.7% 45.9% 284 259
1997 123 121 25.7% 25.3% 356 358
1998 68 96 14.2% 20.0% 411 383
1999 252 149 52.6% 31.1% 227 330
2000 131 177 27.3% 37.0% 348 302
2001 79 79 16.5% 16.5% 400 400
2002 65 58 13.6% 12.1% 414 421
2003 60 56 12.5% 11.7% 419 423
2004 48 66 10.0% 13.8% 431 413
2005 44 74 9.2% 15.4% 435 405
2006 28 75 5.8% 15.7% 451 404
2007 22 25 4.6% 5.2% 457 454
Total 2033 2102 16.3% 16.9% 10405 10336
 Table 7-5
Significant market beta estimates

Significant MRP
Insignificant MRP Significant MRP (%)
CAPM FF CAPM FF CAPM FF
Large-cap 184 239 5069 5014 96.5% 95.5%
discretionary 13 19 939 933 98.6% 98.0%
energy 54 19 422 457 88.7% 96.0%
financials 24 13 894 905 97.4% 98.6%
Health care 21 49 506 478 96.0% 90.7%
Industrials 17 15 782 784 97.9% 98.1%
IT 5 70 692 627 99.3% 90.0%
materials 16 14 324 326 95.3% 95.9%
staples 34 40 510 504 93.8% 92.6%
Micro-cap 1849 1863 5336 5322 74.3% 74.1%
durables 40 35 215 220 84.3% 86.3%
energy 148 141 227 234 60.5% 62.4%
financials 575 539 1225 1261 68.1% 70.1%
Health care 160 210 440 390 73.3% 65.0%
Industrials 366 347 1164 1183 76.1% 77.3%
IT 251 282 979 948 79.6% 77.1%
staples 145 140 365 370 71.6% 72.5%
trade 164 169 721 716 81.5% 80.9%
Total 2033 2102 10405 10336 83.7% 83.1%
 Table 8-1 Market Beta Estimates
(By six common industry sectors, size, and model)

energy financials health care industrials info tech consumer

staples
Large micro Large micro Large micro Large micro Large micro Large micro
1991
CAPM 0.759 0.979 1.196 0.987 1.519 1.079
FF3 0.898 1.190 1.178 1.113 1.582 0.996
1992
CAPM 0.612 0.951 1.278 0.957 1.887 1.100
FF3 0.655 1.080 0.997 1.193 1.995 0.979
1993
CAPM 0.609 0.220 1.147 0.413 1.239 0.851 0.804 0.484 1.885 0.890 1.117 0.655
FF3 0.968 0.536 1.361 0.665 0.739 0.936 0.910 0.658 1.866 1.197 0.910 0.793
1994
CAPM 0.929 0.580 0.941 0.398 1.072 0.857 0.972 0.642 1.712 0.932 0.807 0.593
FF3 1.089 0.718 1.021 0.560 0.987 1.076 1.043 0.811 1.456 1.044 0.684 0.710
1995
CAPM 0.664 0.354 1.002 0.333 0.843 1.038 0.941 0.611 2.366 1.164 0.714 0.530
FF3 0.998 0.571 1.255 0.600 0.688 1.204 1.194 0.884 1.652 1.225 0.530 0.813
1996
CAPM 0.823 0.599 0.989 0.264 1.076 0.891 0.891 0.572 1.609 1.056 0.811 0.488
FF3 1.215 1.038 1.260 0.526 1.101 1.090 1.022 0.819 0.280 1.015 0.855 0.878
1997
CAPM 0.842 0.606 1.006 0.330 1.077 0.667 0.857 0.504 1.572 0.891 0.892 0.452
FF3 1.281 1.067 1.258 0.690 1.054 1.170 1.036 0.927 0.824 1.140 0.880 0.884
1998
CAPM 1.026 0.650 1.182 0.566 0.937 0.788 0.897 0.634 1.374 0.931 0.745 0.649
FF3 1.313 1.071 1.410 0.822 0.842 0.956 1.143 0.952 0.822 1.117 0.742 0.946
1999
CAPM 0.460 0.297 0.957 0.250 0.810 0.446 0.550 0.325 1.481 0.560 0.613 0.332
FF3 1.884 1.263 1.235 0.583 0.795 0.929 1.214 0.974 1.353 1.115 0.614 0.810
2000
CAPM 0.254 0.310 0.682 0.394 0.563 0.858 0.545 0.435 1.727 1.159 0.167 0.364
FF3 1.277 0.783 1.181 0.603 0.881 0.942 1.031 0.728 1.137 1.044 0.592 0.569
2001
CAPM 0.370 0.411 0.775 0.449 0.608 0.955 0.853 0.638 1.927 1.225 0.272 0.533
FF3 0.830 0.702 0.969 0.610 0.839 1.051 1.233 0.931 1.327 1.003 0.594 0.877
2002
CAPM 1.056 0.546 1.000 0.544 0.853 0.795 0.981 0.703 1.670 1.075 0.519 0.616
FF3 1.163 0.707 1.030 0.712 0.729 0.894 1.105 0.926 1.666 1.291 0.488 0.800
2003
CAPM 0.518 0.493 1.058 0.671 0.923 0.875 1.062 0.825 1.569 1.151 0.681 0.651
FF3 0.633 0.608 1.072 0.745 0.870 0.923 1.088 0.907 1.524 1.218 0.670 0.707
2004
CAPM 0.950 1.055 0.935 1.056 0.959 1.452 1.077 1.217 1.554 1.540 0.615 0.964
FF3 0.909 0.881 1.058 0.848 0.969 1.018 1.104 0.963 1.187 1.004 0.734 0.777
2005
CAPM 1.561 1.419 1.011 1.283 0.791 1.192 1.126 1.348 1.152 1.309 0.738 1.038
FF3 1.609 1.217 1.085 1.018 0.806 0.917 1.073 1.030 1.068 0.959 0.797 0.742
2006
CAPM 1.609 1.556 0.888 1.210 0.790 1.234 1.220 1.537 1.289 1.482 0.544 1.071
FF3 1.738 1.368 0.973 0.900 0.835 0.853 1.074 1.067 1.138 0.993 0.649 0.775
2007
CAPM 1.183 1.181 1.308 1.260 0.730 0.901 1.072 1.285 0.969 1.035 0.694 1.079
FF3 1.191 1.107 1.290 1.157 0.741 0.851 1.079 1.213 0.959 0.968 0.710 1.001
 Table 8-2 Equality test of Market Beta Estimates
Large-cap

Average Standard Error P-value Mean Squared Errors

Estimates
year Industry CAPM FF3 capm FF3 ANOVA Between Within Equality
class t_test _F_test group group Test
(A) Test by Year
1991 1.105 1.196 0.025 0.026 0.010 0.010 1.294 0.196 non-equal
1992 1.158 1.234 0.035 0.038 0.146 0.146 0.872 0.411 equal
1993 1.137 1.167 0.033 0.035 0.538 0.538 0.137 0.360 equal
1994 1.066 1.061 0.028 0.027 0.884 0.884 0.005 0.232 equal
1995 1.080 1.103 0.041 0.035 0.673 0.673 0.080 0.449 equal
1996 1.028 1.005 0.025 0.029 0.553 0.553 0.080 0.228 equal
1997 0.997 1.063 0.022 0.022 0.036 0.036 0.673 0.152 non-equal
1998 1.028 1.101 0.020 0.024 0.024 0.024 0.803 0.156 non-equal
1999 0.795 1.180 0.027 0.030 0.000 0.000 22.972 0.251 non-equal
2000 0.663 1.044 0.032 0.024 0.000 0.000 22.470 0.253 non-equal
2001 0.868 1.070 0.035 0.026 0.000 0.000 6.319 0.297 non-equal
2002 1.016 1.058 0.024 0.027 0.241 0.241 0.280 0.203 equal
2003 1.030 1.038 0.023 0.022 0.800 0.800 0.010 0.157 equal
2004 1.048 1.047 0.023 0.017 0.959 0.959 0.000 0.129 equal
2005 1.091 1.075 0.021 0.018 0.573 0.573 0.037 0.117 equal
2006 1.057 1.029 0.026 0.023 0.412 0.412 0.127 0.188 equal
2007 1.035 1.031 0.018 0.017 0.867 0.867 0.003 0.095 equal
(B) Test by Industry
discretionary 1.025 1.149 0.013 0.014 0.000 0.000 7.416 0.165 non-equal
energy 0.837 1.156 0.021 0.024 0.000 0.000 24.246 0.241 non-equal
fin 0.989 1.160 0.014 0.014 0.000 0.000 13.514 0.183 non-equal
health 0.926 0.885 0.018 0.018 0.106 0.106 0.439 0.167 equal
industrials 0.929 1.097 0.012 0.012 0.000 0.000 11.338 0.119 non-equal
it 1.604 1.284 0.023 0.024 0.000 0.000 35.566 0.395 non-equal
materials 0.878 1.091 0.024 0.023 0.000 0.000 7.721 0.190 non-equal
staples 0.712 0.731 0.015 0.013 0.334 0.334 0.095 0.102 equal
 Table 8-3 Equality test of Market Beta Estimates
Micro-cap

Average estimates Standard Error p-value Mean Squared Error

year class Mean Mean se_ se_ p_ ANOVA MSE_ MSE_ Equality
_capm _ff3 capm ff3 T test F test between within test
Test by Year
1993 0.615 0.829 0.029 0.032 0.000 0.000 10.900 0.444 non-equal
1994 0.674 0.833 0.027 0.028 0.000 0.000 6.000 0.356 non-equal
1995 0.672 0.896 0.033 0.037 0.000 0.000 11.938 0.575 non-equal
1996 0.622 0.854 0.025 0.031 0.000 0.000 12.762 0.379 non-equal
1997 0.554 0.947 0.019 0.025 0.000 0.000 36.864 0.235 non-equal
1998 0.698 0.960 0.020 0.024 0.000 0.000 16.350 0.225 non-equal
1999 0.374 0.920 0.017 0.030 0.000 0.000 71.019 0.286 non-equal
2000 0.588 0.777 0.027 0.027 0.000 0.000 8.571 0.351 non-equal
2001 0.717 0.873 0.028 0.027 0.000 0.000 5.737 0.357 non-equal
2002 0.738 0.934 0.022 0.025 0.000 0.000 9.208 0.259 non-equal
2003 0.842 0.917 0.023 0.024 0.022 0.022 1.348 0.255 non-equal
2004 1.236 0.935 0.029 0.021 0.000 0.000 21.527 0.306 non-equal
2005 1.284 0.990 0.025 0.022 0.000 0.000 20.571 0.263 non-equal
2006 1.368 0.973 0.027 0.023 0.000 0.000 37.063 0.300 non-equal
2007 1.173 1.093 0.019 0.018 0.002 0.002 1.543 0.158 non-equal
Test by Industry
durables 0.910 1.062 0.033 0.027 0.000 0.000 2.938 0.233 non-equal
energy 0.685 0.909 0.032 0.037 0.000 0.000 9.390 0.454 non-equal
fin 0.628 0.736 0.013 0.012 0.000 0.000 10.482 0.286 non-equal
health 0.920 0.987 0.025 0.026 0.066 0.066 1.353 0.401 equal
industrials 0.784 0.919 0.015 0.014 0.000 0.000 14.001 0.324 non-equal
it 1.103 1.096 0.021 0.019 0.797 0.797 0.032 0.485 equal
staples 0.668 0.806 0.021 0.023 0.000 0.000 4.856 0.255 non-equal
trade 0.862 1.005 0.018 0.017 0.000 0.000 8.988 0.274 non-equal
 Table 8-4 Statistical Significance of SMB and HML Estimates (t-statistics)

Large-cap stocks (Negatives in parentheses)

SMB 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

discretionary 0.79 1.16 0.93 0.56 0.43 0.99 0.66 1.35 0.60 (0.75) 1.41 0.55 (0.49) (0.81) 0.79 0.34 1.05
energy 0.30 (0.26) 0.62 1.16 1.09 0.94 2.35 1.71 2.76 2.62 2.81 (0.15) 0.82 1.74 1.13 1.63 (0.67)
financials 2.03 1.26 0.93 0.03 0.49 (0.17) (0.44) (0.20) (1.38) (2.96) (0.90) (0.69) (1.65) (2.05) (1.69) (1.82) 0.94
health 0.70 (0.19) (1.07) (0.23) (0.39) (0.02) (0.22) (0.40) 0.04 (0.42) (0.16) (0.55) (0.19) (0.76) (0.77) (1.34) (0.89)
industrials 0.79 0.86 0.09 0.77 1.28 0.40 0.19 0.87 0.73 (1.30) 1.13 0.42 (0.55) (0.48) 0.43 0.94 (0.63)
it 1.35 1.99 1.20 0.14 (0.18) (1.03) 0.43 0.70 0.41 (0.09) 0.48 2.16 2.00 2.32 0.23 (0.19) 0.53
materials (0.04) 0.11 (0.35) 0.44 0.92 0.23 0.44 (0.06) 1.01 (1.37) 0.26 (0.05) (0.49) 0.21 1.21 1.17 0.37
staples (0.90) (0.84) (1.15) (1.50) (2.19) (1.30) (1.46) (1.80) (1.25) (2.81) (0.44) (1.22) (1.54) (2.36) (1.46) (1.66) (1.48)

HML 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
discretionary 0.44 0.88 (0.11) (0.02) 0.54 0.59 1.07 0.99 1.76 2.00 2.90 1.47 (0.03) 0.09 (1.19) (1.46) 0.99
energy 0.79 0.10 2.46 0.81 1.50 1.88 1.01 1.14 4.96 4.60 3.38 0.91 2.36 5.81 ##### 6.62 1.61
finanicals 1.14 1.08 2.03 1.22 2.09 2.24 2.53 1.84 2.72 2.25 2.19 1.43 0.82 0.73 (1.40) (1.01) 2.66
health (1.64) (3.09) (4.15) (1.32) (1.28) 0.03 (0.57) (0.68) (0.38) 1.36 2.10 (2.02) (1.24) (1.71) (2.52) (1.75) (0.77)
industrials 0.97 2.12 1.18 0.36 1.44 0.65 1.14 1.61 3.66 2.22 3.76 2.48 0.61 0.53 (0.65) (0.57) 0.20
it (0.79) (0.16) (1.18) (2.35) (3.25) (4.06) (3.71) (2.81) (0.97) (1.87) (3.08) (1.94) (1.40) (2.63) (3.11) (2.75) (1.72)
materials 1.32 1.83 1.44 0.67 1.88 1.00 2.09 2.27 5.88 3.40 5.79 2.56 1.58 2.35 1.02 0.86 0.92
staples (1.07) (1.44) (1.81) (1.08) (0.64) 0.70 0.65 0.30 0.57 1.68 3.45 (0.16) (0.11) (1.52) (1.40) (0.78) 0.24
 Table 8-5 Statistical Significance of SMB and HML Estimates (t-statistics)

Small-cap stocks (Negatives in Red)

SMB 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
durables 1.71 2.09 2.11 1.98 2.85 3.21 2.08 1.13 2.88 3.68 3.04 2.29 2.69 2.65 4.82
energy 0.87 1.18 0.99 0.92 2.26 2.85 1.89 1.55 2.59 1.66 1.42 2.03 2.65 2.91 2.71
financials 1.27 1.48 1.20 1.23 1.86 2.69 1.35 0.61 2.10 3.08 3.35 2.70 3.03 2.83 5.24
health 1.25 1.62 1.08 1.76 1.91 2.29 1.40 2.19 1.57 1.95 2.30 2.54 1.73 1.82 2.18
industrials 1.11 1.61 1.57 1.64 2.33 2.92 1.80 0.74 2.67 2.84 2.66 2.32 2.91 3.14 3.06
it 1.77 1.53 1.51 1.59 2.36 3.19 2.08 1.95 2.16 2.92 3.38 3.70 2.53 2.50 2.88
staples 1.37 1.46 1.39 1.50 1.99 2.96 1.58 0.53 2.59 2.38 1.91 1.58 2.77 2.14 3.64
trade 1.21 1.58 1.54 1.97 2.08 2.62 1.76 0.91 2.32 3.02 2.80 2.34 2.26 2.56 3.24

HML 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
durables 0.52 0.29 0.72 0.62 1.55 1.07 2.36 1.37 1.83 2.24 0.47 0.11 0.07 0.69 0.03
energy 0.70 0.32 0.70 0.75 0.53 1.07 2.47 1.92 1.88 0.96 1.48 2.85 6.15 4.47 0.72
financials 0.86 0.55 0.89 0.92 1.05 1.23 1.56 1.06 1.52 1.76 1.08 0.66 0.18 0.27 2.37
health 0.74 0.08 0.10 0.05 0.40 0.25 0.81 0.51 0.61 0.02 0.09 0.43 0.89 0.65 0.26
industrials 0.57 0.45 0.77 0.76 1.14 1.44 2.51 1.42 2.40 1.98 0.95 0.74 0.28 0.33 0.69
it 0.39 0.29 0.48 0.55 0.29 0.36 1.12 0.11 0.69 0.47 0.18 0.63 0.92 0.82 0.15
staples 0.29 0.12 0.84 1.08 1.17 1.06 1.53 0.93 2.26 1.59 0.45 0.09 0.03 0.14 1.22
trade 0.07 0.38 0.63 0.77 0.96 0.94 1.93 1.26 1.76 1.63 0.79 0.07 0.25 0.47 1.35
Table 9 SBC (or BIC) Information Criteria of the CAPM and the FF3 model

Large-cap 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
discretionary
CAPM -5.00 -5.1 -5.3 -5.4 -5.4 -5.3 -5.3 -4.9 -4.7 -4.3 -4.8 -4.9 -5.6 -5.8 -5.8 -5.7 -5.6
FF3 -4.98 -5.1 -5.3 -5.4 -5.4 -5.3 -5.3 -4.8 -4.7 -4.3 -4.8 -4.9 -5.6 -5.8 -5.8 -5.7 -5.6
energy
CAPM -4.81 -4.7 -4.9 -5.1 -5.3 -5.3 -5 -4.3 -4.2 -4.1 -4.4 -4.8 -5.4 -5.4 -5.2 -5.1 -5.5
FF3 -4.80 -4.7 -4.9 -5.1 -5.3 -5.2 -5 -4.3 -4.3 -4.2 -4.4 -4.7 -5.4 -5.5 -5.6 -5.2 -5.5
financials
CAPM -5.37 -5.7 -5.6 -5.8 -6 -5.9 -5.6 -5.1 -5 -4.5 -5.3 -5.6 -6.2 -6.4 -6.5 -6.5 -5.7
FF3 -5.36 -5.6 -5.6 -5.8 -6 -6 -5.7 -5.1 -5.1 -4.6 -5.4 -5.6 -6.2 -6.4 -6.4 -6.5 -5.7
health
CAPM -5.14 -5.2 -4.9 -5.4 -5.4 -5.2 -5.1 -4.7 -4.5 -4 -4.7 -4.7 -5.4 -5.5 -5.8 -5.8 -5.9
FF3 -5.14 -5.2 -5 -5.4 -5.4 -5.2 -5.1 -4.7 -4.5 -4.1 -4.7 -4.7 -5.4 -5.5 -5.8 -5.8 -5.9
industrials
CAPM -5.30 -5.4 -5.6 -5.7 -5.7 -5.7 -5.5 -5 -4.7 -4.4 -5 -5.2 -5.8 -6.1 -6.2 -6 -5.9
FF3 -5.28 -5.4 -5.6 -5.6 -5.7 -5.6 -5.5 -5 -4.7 -4.4 -5.1 -5.2 -5.7 -6.1 -6.1 -6 -5.9
IT
CAPM -4.41 -4.5 -4.5 -4.7 -4.6 -4.3 -4.4 -4.2 -4 -3.6 -3.9 -4.1 -4.9 -5.2 -5.4 -5.4 -5.6
FF3 -4.40 -4.5 -4.5 -4.7 -4.6 -4.4 -4.4 -4.3 -4 -3.6 -3.9 -4.2 -4.9 -5.2 -5.5 -5.4 -5.6
materials
CAPM -5.48 -5.6 -5.7 -5.7 -5.7 -5.8 -5.7 -5.1 -4.7 -4.4 -5.1 -5.1 -5.9 -6.1 -6 -6 -5.9
FF3 -5.45 -5.5 -5.7 -5.7 -5.7 -5.8 -5.7 -5.1 -4.8 -4.5 -5.2 -5.1 -5.9 -6.1 -6 -6 -5.9
staples
CAPM -5.61 -5.6 -5.5 -5.7 -5.8 -5.7 -5.4 -5.2 -4.9 -4.4 -5.2 -5.2 -6 -6.3 -6.3 -6.3 -6.2
FF3 -5.60 -5.6 -5.5 -5.7 -5.8 -5.7 -5.4 -5.1 -4.9 -4.4 -5.2 -5.2 -6 -6.3 -6.2 -6.3 -6.2
Table 9 (cont’d)

Micro-cap 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
durables
CAPM -4.51 -4.73 -4.91 -4.76 -4.92 -4.46 -4.36 -4.06 -4.18 -4.40 -4.79 -5.10 -5.05 -4.94 -4.64
FF3 -4.49 -4.72 -4.90 -4.74 -4.92 -4.47 -4.36 -4.04 -4.19 -4.44 -4.79 -5.09 -5.06 -4.95 -4.70
energy
CAPM -3.59 -3.88 -3.93 -3.89 -4.03 -3.75 -3.60 -3.73 -4.07 -4.16 -4.50 -4.51 -4.54 -4.71 -4.70
FF3 -3.56 -3.85 -3.90 -3.86 -4.02 -3.75 -3.61 -3.73 -4.08 -4.15 -4.50 -4.53 -4.69 -4.77 -4.72
financials
CAPM -4.50 -4.73 -4.89 -5.05 -4.98 -4.68 -4.76 -4.47 -4.82 -5.03 -5.46 -5.64 -5.68 -5.79 -5.15
FF3 -4.48 -4.71 -4.86 -5.02 -4.96 -4.69 -4.75 -4.46 -4.82 -5.06 -5.49 -5.65 -5.70 -5.81 -5.27
health
CAPM -3.67 -3.65 -3.58 -3.74 -3.77 -3.51 -3.46 -3.04 -3.42 -3.69 -4.14 -4.24 -4.41 -4.68 -4.72
FF3 -3.65 -3.63 -3.55 -3.73 -3.75 -3.50 -3.43 -3.04 -3.41 -3.68 -4.13 -4.24 -4.39 -4.67 -4.73
industrials
CAPM -4.71 -4.77 -4.89 -4.87 -4.91 -4.60 -4.35 -4.19 -4.49 -4.57 -4.91 -5.08 -5.09 -5.01 -4.84
FF3 -4.68 -4.75 -4.87 -4.85 -4.91 -4.61 -4.36 -4.19 -4.51 -4.59 -4.92 -5.08 -5.10 -5.03 -4.86
IT
CAPM -3.96 -4.03 -4.02 -3.94 -4.13 -3.84 -3.76 -3.34 -3.55 -3.73 -4.29 -4.67 -4.78 -4.81 -4.77
FF3 -3.94 -4.01 -4.02 -3.94 -4.14 -3.86 -3.75 -3.35 -3.57 -3.75 -4.31 -4.70 -4.78 -4.81 -4.79
staples
CAPM -4.48 -4.67 -4.65 -4.64 -4.64 -4.23 -4.33 -4.15 -4.40 -4.61 -5.04 -5.05 -5.17 -5.21 -4.82
FF3 -4.45 -4.65 -4.63 -4.62 -4.63 -4.24 -4.31 -4.12 -4.40 -4.61 -5.03 -5.03 -5.17 -5.20 -4.87
trade
CAPM -4.52 -4.59 -4.76 -4.53 -4.65 -4.17 -4.12 -3.81 -4.10 -4.31 -4.69 -4.92 -4.96 -5.07 -4.69
FF3 -4.49 -4.57 -4.73 -4.52 -4.63 -4.17 -4.10 -3.79 -4.10 -4.32 -4.70 -4.92 -4.96 -5.08 -4.73
Table 10 Residual test for Serial Correlation and Heteroskedasticity

Large-cap Heteroskedasticity Non-hetero Total Heteroskedasticity Non-hetero Total

CAPM 14.6% 85.4% 100.0% 11.4% 88.6% 100.0%
Serially 3.0% 13.9% 16.9% 4.4% 35.3% 39.8%
correlated
non- 11.6% 71.5% 83.1% 7.0% 53.2% 60.2%
correlated
FF3 19.7% 80.3% 100.0% 18.0% 82.0% 100.0%
Serially 4.0% 13.6% 17.6% 6.9% 33.2% 40.1%
correlated
non- 15.7% 66.7% 82.4% 11.0% 48.8% 59.9%
correlated

350

300

250 Residuals: large-cap

200
non-auto - non-hetero
150
non-auto - hetero
100
auto - non-hetero
50
auto - hetero
0
1999

2001

2003

2000

2002

2004
1991

1993

1995

1997

2005

2007

1992

1994

1996

1998

2006

capm ff3

500
450
400 Residuals: micro-cap
350
300
250 non-auto - non-hetero
200 non-auto - hetero
150
auto - non-hetero
100
50 auto - hetero

0
1997

1999

2001

1993

1995

1997

2004

2006
1993
1994
1995
1996

1998

2000

2002
2003
2004
2005
2006
2007

1994

1996

1998
1999
2000
2001
2002
2003

2005

2007

capm ff3

57
 Figure 1
Stock Return Correlations with MRP by industry

0.80 Correlations of large-cap stock returns

0.70 with the market index Discretionary
0.60 energy
0.50 fin
0.40 health
0.30
industrial
0.20
it
0.10
materials
0.00
staples
1994

1996

1998

2000
1991
1992
1993

1995

1997

1999

2001
2002
2003
2004
2005
2006
2007
0.60
Correlations of micro-cap stock returns
0.50 with the market index durables
energy
0.40
fin
0.30 health
0.20 industrials
it
0.10
staples
0.00
trade
1995

1996

2001

2002

2007
1993

1994

1997

1998

1999

2000

2003

2004

2005

2006

58
 0%
5%

0%
20%
25%
30%
35%
40%

10%
15%

10%
20%
40%
50%

30%

0
20000
40000
60000
80000
100000
120000
1926 Date
1926 7/2/1991
1929
1929 1/2/1992
1932 7/2/1992
1932
1935 1/4/1993
1935
1938 7/6/1993

Amex
1938 1/4/1994
1941
1941 7/7/1994
1944 1/6/1995
1944

NYSE
1947 7/10/1995
1947
1950 1/9/1996
1950
1953 7/10/1996
1953

Figure 2-2
1/9/1997
1956
1956 7/11/1997

NASDAQ
1959 1/12/1998
1959

59
1962 7/15/1998
1962
Figure 2

1/14/1999
1965 1965
% of daily non-trading stocks 7/19/1999
1968 1968
(Annual aggregation of all stocks, 1926-2007) 1/18/2000
1971 1971 7/19/2000
1974 1/19/2001

(total of monthly count)

1974
1977 7/23/2001
1977
1/29/2002
1980 1980
7/31/2002
Non-trading (zero return data) and NASDAQ stocks

1983 1983

Figure 2-3: Stocks by Prime Exchange

1/31/2003
Figure 2-1

1986 1986 8/4/2003

Micro-cap stocks

1989 1989 2/4/2004

1992 8/6/2004
1992
(Daily aggragation, 1991-2007)

2/7/2005
1995 1995
% of daily non-trading stocks

8/9/2005
1998 1998 2/9/2006
2001 2001 8/11/2006
2004 2004 2/14/2007
8/16/2007
2007 2007