COURSE TITLE: SEMINOR IN FINANCE COURSE CODE: MPH 622
Presentation on
The Cross-Section of Realized Stock
Returns: The Pre...
 Research question
Is there ability of certain variables to explain the cross-sectional
variation in realized stock retur...
Continue….
 Review of literature & research gap
Relationship between book-to-market equity and
stock returns
Rosenberg, R...
Continue….
 Hypotheses: (Null hypotheses)
o H1: The correlation between the variables and subsequent returns do
not refle...
Continue….
 Limitations
o Includes only the largest firms of NYSE in the top half of the size
spectrum.
o The ratio of bo...
Continue….
 Sources of data
Two primary sources
Moody Industrial Manuals: for book value earnings, cash flow, and
sales a...
Continue….
 Variables
o Book-to-market equity
o Cash flow yield
o Earning yield and
o Historical sales growth use as prim...
Continue….
 Procedures of analysis
Ranking
o First, the stocks were ranked by the variables and quintiles were
formed.
o ...
 Empirical results
Portfolio results
i) Ranking on the basis certain variables produces dispersion in
returns.
ii) There ...
Regression results: (return vs. other variables)
iii) There significant relationship between book-to-market equity and
sub...
Continue….
Seasonal patterns
viii) There is significance of LBM, E/P+, and CF/P+ with return mostly
in January.
Beta LBM C...
Conclusions
Book-to-market equity, earning yield, and cash flow yield have
significant explanatory power with respect to ...
Thank you.
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The Cross Section of Realized Stock Returns: The Pre-COMPUSTAT Evidence

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The Cross Section of Realized Stock Returns: The Pre-COMPUSTAT Evidence

  1. 1. COURSE TITLE: SEMINOR IN FINANCE COURSE CODE: MPH 622 Presentation on The Cross-Section of Realized Stock Returns: The Pre-COMPUSTAT Evidence Article written by: James L. Davas, Kansas State University, USA Article published in: Journal of Finance, Vol. XLIXI No. 5 (December 1994), pp. 1579-1593 3rd March, 2011
  2. 2.  Research question Is there ability of certain variables to explain the cross-sectional variation in realized stock returns?  Objectives To analyze the explanatory power of book-to-market equity, earning yield, sales growth, firm size, stock price and historical beta with respect to the cross-section of realized stock returns. To find the January seasonal explanatory power of these variables.  Nature and Purpose Explanatory (to establish the relationship between the variables)  Methodology : Primary sources  Approach : Quantitative  Research Design : Causal correlation and descriptive Continue….
  3. 3. Continue….  Review of literature & research gap Relationship between book-to-market equity and stock returns Rosenberg, Reid and Lanstein (1985), De Bondt and Thaler (1987), Chan, Hamao and Lakonishok (1991) and Fama and French (1992) Relationship between earning yield and stock returns Basu (1977), Jaffe, Keim and Waterfield (1989) Relationship between cash flow yield and stock returns Chan, Hamao and Lakonishok (1991) Relationship between historical sales growth and stock returns Lakonishok, Shleifer, and Vishny (1993) Seasonality is the explanatory power of earnings yield Jaffe, Keim and Waterfield (1989) January seasonal in the magnitude of the regression coefficient on book-to-market equity Fama and French (1992). To confirm the relationship of the variables on earlier studies using different time frame and methodologies Research gap
  4. 4. Continue….  Hypotheses: (Null hypotheses) o H1: The correlation between the variables and subsequent returns do not reflects compensation for bearing risk. o H2: The variables doe not allow investors to identify stocks that are mispriced. o H3: The observed predictive ability is not an artifact of the research design and database used to conduct the study, and the predictive ability of certain variables would be reduced or vanish if different methodology and data were used. These hypotheses which are based on the study of Fama and French (1993), Lakonishok, Shleifer, and Vishny (1993) and Kothari, Shanken, and Sloan (1993) respectively. H1 & H2 = Explanatory power H3 = Methodologies
  5. 5. Continue….  Limitations o Includes only the largest firms of NYSE in the top half of the size spectrum. o The ratio of book-to-market equity was calculated on the basis of accounting information rather than market value of equity. o Use of accounting information for analysis may be affected by the COMPUSTAT related problems. But, the survivorship bias in the selection of firms, Davis (1994), Banz and Breen (1986) and problem of a look-ahead bias, Banz and Breen (1986) have been eliminated by employing Moody’s Industrial Manuals. However, Data snooping, Lo and MacKinlay (1990) and short sample period problems still remains in the study.
  6. 6. Continue….  Sources of data Two primary sources Moody Industrial Manuals: for book value earnings, cash flow, and sales and, University of Chicago, Center for Research in Security Prices (CRSP): for stock returns, stock prices and market values of equity.  Sample 100 firms selected on top half of the June 30 size ranking and listed in the Moody’s Industrial Manual.  Study period From 1940 to the early 1960s Reasons - first, fairly constant volatility in the stock market compare with 1930s and availability of the accounting information.
  7. 7. Continue….  Variables o Book-to-market equity o Cash flow yield o Earning yield and o Historical sales growth use as primary focus. BETA (historical betas base), Firm size, Share price, LBM, LMV, E/P, CF/P, GROWTH (five year compound annual average sales growth rate) and LPRICE as of each June 30 for each firms also included as secondary variables. ttl: 13 variables = 4 + 9
  8. 8. Continue….  Procedures of analysis Ranking o First, the stocks were ranked by the variables and quintiles were formed. o Second, the returns, systematic risk, and other characteristics of these quintiles were analyzed. Portfolio o First portfolio was formed with the top third of the CF yield ranking and in the bottom third of the sales growth ranking. (top 3 + bottom 3) o Second portfolio was formed with the bottom third of the CF yield ranking and in the top third of the sales growth ranking. (bottom 3 + top 3 ) Cross-sectional regression o Fama-MacBeth (1973) cross-sectional regression analysis use to determine the explanatory power of realized returns. o Monthly regressions were run for whole period and results were presented for all months, for January only, and for February-December only.
  9. 9.  Empirical results Portfolio results i) Ranking on the basis certain variables produces dispersion in returns. ii) There are correlations among the variables. (multicollienarity) Continue…. Portfolio sorted by 0 (Neg.) 1 (Low) 5 (High) I Dispersion I Earning/Price 11.91 13.48 23.04 9.56* Cash Flow/Price 13.46 12.54 22.07 9.53* 5 Year Sales Growth 15.67 15.58 0.09 Firm Size 18.13 15.03 3.10 Stock Price 20.17 15.42 4.75 Book/Market 14.24 21.06 6.82* Historical Beta 13.47 18.19 4.72 Cross-sectional correlation Mean Corr.(E/P, CF/P) 0.83 Multicollinearity Mean Corr.(CF/P, LBM) 0.66 Mean Corr.(E/P, LBM) 0.50 Mean Corr.(LP, LMV) 0.45 Mean Corr.(LP, LBM) -0.42 Others Mean Corr. <0.32
  10. 10. Regression results: (return vs. other variables) iii) There significant relationship between book-to-market equity and subsequent returns. iv) Cash flow yield has explanatory power with respect to subsequent realized returns when book-to-market equity and historical sales growth are held constant. (conditional relationship) v) Earning yield has also explanatory power to predict subsequent returns. vi) There is insignificant explanatory power for beta to predict returns. vii) There is a weak relationship between sales growth and returns. Beta LBM CF/P+ CFPNEG E/P+ EPNEG GROWTH Avg. Adj R2 0.15 0.029 0.26* 0.020 1.64 0.29 0.021 4.35* 0.52 0.023 -0.46 0.010 1.56 0.43 -0.45 0.031 -0.05 2.55* 0.2 -0.56 0.040 Continue….
  11. 11. Continue…. Seasonal patterns viii) There is significance of LBM, E/P+, and CF/P+ with return mostly in January. Beta LBM CF/P+ CFPNEG E/P+ EPNEG GROWTH Avg. Adj R2 Panel A: January Only (23 obs) 0.20 0.028 1.95* 0.043 15.83* 3.77 0.030 25.54* 4.73 0.033 -4.59 0.014 16.31* 4.45 -4.60 0.043 1.15 9.12* 5.00 -3.41 0.061 Panel B: Feb-Dec (253 Obs) 0.15 0.029 0.11 0.018 0.35 -0.02 0.020 2.42 0.14 0.022 -0.08 0.010 0.22 0.06 -0.07 0.030 -0.15 1.95 -0.24 -0.30 0.038
  12. 12. Conclusions Book-to-market equity, earning yield, and cash flow yield have significant explanatory power with respect to the cross-section of realized stock returns during the study period and, There is a strong January seasonal in the explanatory power of book-to- market equity, earning yield and cash flow yield.  Critical appraisal This work has found out the relationship between the variables which had already been identified, thus it is believed that it validates the former. Contains of the article is quite repetitive. Continue….
  13. 13. Thank you.

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