Recent research has documented the failure of market beta to capture the cross-section of expected returns within the context of a two-pass estimation methodology. However, the two-pass methodology suffers from the errors-in-variables (EIV) problem that could attenuate the apparent significance of market beta. This article provides a new correction for the EIV problem that is robust to conditional heteroscedasticity. After the correction, I find more support for the role of market beta and less support for the role of firm size in explaining the cross-section of expected returns. While the EIV correction leads to a diminished role of firm size, the size variable remains a significant force in explaining the cross-section of expected returns.

Dongcheol Kim, A Reexamination of Firm Size, Book-To-Market, and Earnings Price in the Cross-Section of Expected Stock Returns, The Journal of Financial and Quantitative Analysis, Vol. 32, No. 4 (Dec., 1997), pp. 463-489

Recent research has documented the failure of market beta to capture the cross-section of expected returns within the context of a two-pass estimation methodology. However, the two-pass methodology suffers from the errors-in-variables (EIV) problem that could attenuate the apparent significance of market beta. This article provides a new correction for the EIV problem that is robust to conditional heteroscedasticity. After the correction, I find more support for the role of market beta and less support for the role of firm size in explaining the cross-section of expected returns. While the EIV correction leads to a diminished role of firm size, the size variable remains a significant force in explaining the cross-section of expected returns.

Recent research has documented the failure of market beta to capture the cross‐section of expected returns within the context of a two‐pass estimation methodology. However, the two‐pass methodology suffers from the errors‐in‐variables (EIV) problem that could attenuate the apparent significance of market beta. This article provides a new correction for the EIV problem that is robust to conditional heteroscedasticity. After the correction, I find more support for the role of market beta and less support for the role of firm size in explaining the cross‐section of expected returns. While the EIV correction leads to a diminished role of firm size, the size variable remains a significant force in explaining the cross‐section of expected returns.

This paper examines the effect of commercial bank entry on underwriting spreads for IPOs, SEOs, and debt issues using a long time series that spans 30 years, from 1975 to 2004. We find that, on average, commercial banks charge lower spreads of approximately 72 basis points for IPOs, 43 basis points for SEOs, and 14 basis points for debt over the entire sample period. The economic impact of commercial banks on lowering underwriting spreads is most significant when commercial banks were allowed to enter via Section 20 subsidiaries but persists beyond. Commercial bank entry into underwriting appears to have a procompetitive effect that lasts many years after their initial entry.

To explain post-earnings announcement drift, we construct a risk factor related to unexpected earnings surprise, and propose a four-factor model by adding this risk factor to Fama and French's (1993), (1995) three-factor model. This earnings surprise risk factor provides a remarkable improvement in explaining post-earnings announcement drift when included in addition to the three factors of Fama and French. After adjusting raw returns for the four risk factors, the cumulative abnormal returns over the 60 trading days subsequent to quarterly earnings announcements are economically and statistically insignificant. Furthermore, except for the first two days after the earnings announcement, the cumulative abnormal returns and the arbitrage returns from our four-factor model are relatively stable over the testing period and never significant on any day of the testing period. On the other hand, the arbitrage returns from the other models increase over the 60-day testing period. We argue that most of the post-earnings announcement drift observed in prior studies may be a result of using misspecified models and failing to appropriately adjust raw returns for risk.

This paper examines the equilibrium relation between future labor income growth and expected asset returns; it proposes revisions in the expectation of future labor income growth as a macroeconomic state variable and suggests a three-factor model, including a factor related to this variable, along with the consumption growth factor and the market factor. The proposed future labor income growth factor is positively associated with the Fama–French factors and subsumes their explanatory power in explaining the cross-section of stock returns. These results provide a possible economic explanation for the roles of the Fama–French factors: they are compensation for higher exposure to the risk related to changes in the value of human capital. This paper also compares the performance of the proposed three-factor model with other competing models and finds that the proposed model specification better captures cross-sectional variation in average returns than any of the competing asset pricing models considered.

This study examines whether and how earnings quality, measured as accruals quality (AQ), affects the cost of equity capital. Using two-stage cross-sectional regression tests, we find that the AQ risk factor is significantly priced, after controlling for low-priced stocks. This result is robust in tests using individual stocks, various portfolio formations, and different beta estimations. Furthermore, we show that AQ and its pricing effect systematically vary with business cycles and macroeconomic variables. In particular, this pricing effect is prominent in total AQ and innate AQ but not in discretionary AQ. The risk premium associated with AQ exists only in economic expansion but not in recession periods. Poorer AQ firms are more vulnerable to macroeconomic shocks. The risk premium and the dispersion of AQ are also related to future economic activity. Overall, our results suggest that AQ contributes to the cost of equity capital and that its pricing effect is associated with fundamental risk.

This paper examines the time variations of expected momentum profits using a two-state Markov switching model with time-varying transition probabilities to evaluate the empirical relevance of recent rational theories of momentum profits. We find that in the expansion state the expected returns of winner stocks are more affected by aggregate economic conditions than those of loser stocks, while in the recession state the expected returns of loser stocks are more affected than those of winner stocks. Consequently, expected momentum profits display strong procyclical variations. We argue that the observed momentum profits are the realization of such expected returns and can be interpreted as the procyclicality premium. We provide a plausible explanation for time-varying momentum profits through the differential effect of leverage and growth options across business cycles.