Size And Book-To-Market Accounting Case Study

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Starting from the late 1970’s, empirical examinations of the traditional CAPM indicate the possible existence of anomalous excessive returns related to size, book-to-market, earnings yield and leverage variables among others. Ball (1978) suggest that the Earnings Price (E/P) ratio, an accounting variable obtained by dividing the earnings of a firm with its stock price, may be a direct proxy for expected returns. He states that the abnormal returns on stocks following earnings announcements are not explained by the CAPM. In light of the deficiencies associated with the CAPM, especially the use of a questionable market portfolio proxy as per Roll (1977), the E/P is an important factor in explaining expected returns (Ball, 1978). However Reinganum…show more content…
However they find that the explanatory power of E/P ratios is absorbed by size and book-to-market equity, thereby contradicting Basu (1983) who records the E/P ratio as more dominant than the size variable. Unlike (Ball, 1978; Reinganum, 1981), Fama and French (1992) observe that the mixture of book-to-market equity and size appear to capture the roles of leverage and E/P ratio in explaining average expected returns for the 1963-1990 sample period. These results also contradict Bhandari (1988) who finds that leverage risk can be a proxy for expected returns and Ball (1978) whose findings conclude that E/P ratio is the most relevant…show more content…
Including a proxy for the return on human capital enhances the predictive ability of the model Jagannathan and Wang (1996) and allowing beta to vary over time reduces the explanatory power of size and book-to-market variables. Clare and Priestley (1998) find a positive and significant relationship between beta and average stock returns. A thesis by Gillette (2005), states that the presence of anomalies may point out to market inefficiency since it should not be possible to earn excessive returns based on observable firm characteristics such as size and book to market
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