Abstract

The value premium in U.S. stock returns is robust. The positive relation between average return and book-to-market equity is as strong for 1929 to 1963 as for the subsequent period studied in previous papers. A three-factor risk model explains the value premium better than the hypothesis that the book-to-market characteristic is compensated irrespective of risk loadings.

Scientific Portfolio AI- Generated Summary

This paper investigates the relationship between stock returns and firm-specific characteristics, focusing on the effects of size (market capitalization) and book-to-market equity (BE/ME) ratios over a nearly seven-decade period from 1929 to 1997. Fama, French, and Davis use this extended data to validate the Fama-French three-factor model, which posits that returns can be largely explained by three factors: market risk, size (small vs. large firms), and value (high vs. low BE/ME firms).

Their findings indicate that both small-cap stocks and high book-to-market stocks (value stocks) historically outperform large-cap stocks and low BE/ME stocks (growth stocks), showing that the value premium—the return advantage of high BE/ME stocks—is consistent across the long-term data set. By dividing the time frame into pre-1963 and post-1963 periods, the study demonstrates that these return characteristics are not merely artifacts of specific decades but are robust across market cycles and economic conditions.

The authors also delve into the theoretical underpinnings of the three-factor model, arguing that the value and size premiums represent compensation for risk rather than mere statistical anomalies. By examining covariances between these factors and market returns, they show that the premiums can be attributed to underlying risk exposures. Specifically, the low correlation between size (SMB) and value (HML) factors supports the idea that these factors capture distinct sources of risk rather than overlapping or redundant characteristics.

Through rigorous empirical testing, the paper underscores the significance of the three-factor model in capturing systematic return variations that single-factor models cannot explain. This research offers important insights for both academics and practitioners in understanding the role of size and value in shaping equity returns, reinforcing the notion that investors are rewarded for bearing these specific risks over the long term.