Some recent observations on the performance and risk characteristics of common stocks.

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Presentation transcript:

Some recent observations on the performance and risk characteristics of common stocks

Objectives Compare and contrast the relative performance of cheap and expensive stocks.

Definition Cheap stock = Low market-to-book ratio Expensive stock = High market-to-book ratio

Outline Experiment 1 Experiment 2 Discussion

EXPERIMENT 1 (Fama and French) average realized returns market-to-book ratios Analyze the relationship between average realized returns and market-to-book ratios.

EXPERIMENT 1 Year 1 Rank all stocks according to market-to-book ratio. Divide them into ten groups. At the end of the year calculate the average realized return for each group (portfolio). Year 2 Re-rank all stocks according to market-to-book ratio. Divide them into ten groups. At the end of the year re-calculate the average realized return for each group (portfolio). Repeat this for 30 years

Relationship between market-to-book ratio and average annual return for American stocks.

EXPERIMENT 2 market riskmarket- to-book ratios. An analysis into the relationship between market risk and market- to-book ratios.

EXPERIMENT 2 Year 1 Rank all stocks according to their last year's beta. At the end of the year, calculate the market-to-book ratios. Year 2 Re-rank all stocks according to their last's year beta. At the end of the year, calculate the market-to-book ratios. Redo this procedure for all 30 years.

Relationship between risk and market-to-book ratio for American stocks

Discussion Experiment 1: Portfolios of cheaper stocks appear to earn higher returns than portfolios of expensive stocks. Experiment 2: Riskier portfolios (in terms of systematic risk) tend to have higher market-to-book ratios, that is, appear to be more expensive.

Question What is then, the observed relationship between risk and return for American stocks?