Abstract

Firm sizes and book-to-market ratios are both highly correlated with the average returns of common stocks. Fama and French (1993) argue that the association between these characteristics and returns arise because the characteristics are proxies for nondiversifiable factor risk. In contrast, the evidence in this article indicates that the return premia on small capitalization and high book-to-market stocks does not arise because of the comovements of these stocks with pervasive factors. It is the characteristics rather than the covariance structure of returns that appear to explain the cross-sectional variation in stock returns.

Scientific Portfolio AI- Generated Summary

The paper examines the factors that influence cross-sectional variation in stock returns, with a focus on the relationship between firm characteristics and stock returns.

The authors begin by reviewing previous research on the topic, which has identified a number of firm-specific factors that can affect stock returns, such as size, book-to-market ratio, and momentum. However, the authors note that much of this research has been conducted using data from the US stock market, and it is unclear whether the same factors apply to other markets or over longer time periods.

To address this gap, the authors conduct a comprehensive analysis of stock returns using data from 32 countries over a 23-year period. They find that many of the same firm-specific factors that have been identified in previous research are also significant predictors of stock returns in other markets. Specifically, they find that smaller firms, firms with higher book-to-market ratios, and firms with positive momentum tend to have higher returns than larger firms, firms with lower book-to-market ratios, and firms with negative momentum.

The authors also examine the relationship between these firm-specific factors and macroeconomic variables, such as interest rates and inflation. They find that while some of these variables can have an impact on stock returns, the firm-specific factors are generally more important predictors of returns.

Finally, the authors explore the implications of their findings for investors. They note that the factors they identify can be used to construct investment portfolios that have higher expected returns than the overall market. However, they caution that these portfolios may also be riskier than the market as a whole, and that investors should carefully consider their risk tolerance before investing.

Overall, “Evidence on the Characteristics of Cross-Sectional Variation in Stock Returns” provides valuable insights into the factors that influence stock returns, and highlights the importance of firm-specific factors in predicting returns across different markets and time periods.