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Abstract:
Studies that have investigated the cross-section of average returns on common stocks in the United States have found evidence that factors related to firm size (market equity) and style (book equity to market equity) help explain the cross-section of average stock returns. This paper tests the explanatory power of such factors in Australia. Further, we also investigate the claim that the size and style effect is the result of seasonal phenomena. We find general support for the three-factor model of Fama and French (1996). We also reject the claim that these effects are exclusively a seasonal phenomenon.
1. Introduction
A large number of studies have investigated the cross-section of average returns on common stocks in the United States and have found little relationship with the estimated beta of the single-factor model. This paper tests the joint roles of an overall market factor, and factors related to firm size (market equity) and style (book equity to market equity) in the cross-section of average stock returns in Australia.
Campbell (2000) reports that, for the last 20 years, theoretical and empirical developments in the United States have taken place within a well-established paradigm. However, to date, few studies have investigated whether the US findings carry over to other markets. This is potentially important because the US results may be sample specific, driven by domestic regulatory, market microstructure and institutional arrangements. For instance, Arshanapalli, Coggin and Doukas (1998) emphasize the point that without testing the robustness of the findings of FF outside the environment in which they were originally found, we cannot determine whether these empirical regularities are merely spurious correlations that may not be confirmed across capital markets.
In advancing the asset pricing debate, the purpose of this paper is to discuss in more detail the multifactor asset-pricing model developed by Fama and French (hereafter FF) (1996), with a view to testing the empirical validity of the model for Australia. The objective of this paper is to consider two specific research questions. First, we investigate whether an overall market factor, firm size and book-to-market equity effect can explain the cross-sectional pattern of stock returns. Specifically, we ask whether the model of FF (1996) explains returns for Australian portfolios. We also examine the January and July...