The Cross-Section of Expected Stock Returns
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What they found
Fama and French examined what explains differences in average returns across U.S. stocks from 1963 to 1990. The surprising result was that market beta, the central variable of the CAPM, had essentially no relationship with average returns once size was controlled for. Two simple variables did the work instead: firm size (small beats large) and book-to-market ratio (cheap beats expensive). The paper effectively declared the CAPM dead as a description of stock returns and launched the multifactor era.
What you can use
- High-beta stocks did not earn higher returns than low-beta stocks; taking more 'market risk' was not rewarded.
- Cheap stocks (high book-to-market) beat expensive ones by a wide margin over this sample.
- Size and value captured what beta was supposed to, which is why every factor model since includes them.
Caveats
Sample 1963 to 1990. The value premium has been much weaker since 2007, especially in large-cap U.S. stocks. Whether value and size are risk or mispricing is still debated.
Tags: factor, value, size, capm, equities
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.