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0.3
0.2
j rj,t = Aj + j rM,t + j,t
0.1
Aj
0 rM,t
0 0.2 0.4 0.6
2. Rank order all of the stock betas, and form 10
portfolios:
Top 10% with the highest betas comprise
portfolio #1, next 10% portfolio #2, . . . and so
forth until portfolio #10 contains the bottom
10% with the smallest betas.
3. Compute each of the portfolios returns for each
of the 12 months in 1931:
n
r
j1
j,t
rp, t
n
4. Repeat Steps 1 through 3 many times:
r p, t
rp t 1
420
rp, t A p prM, t p, t
420 data points
p
Results of the BJS Study
The results of the study appeared to be
consistent with the zero beta version of
the Capital Asset Pricing Model (CAPM):
The intercept of the SML was greater
than the interest rate on risk-free bonds.
The slope of the SML, which was highly
significant was linear and positive.
Also note that Black, Jensen, and Scholes,
estimated the ex post Security Market
Lines in various subperiods. In general,
the results were similar.
Fama - MacBeth Study
Sample: All stocks on the NYSE (1926 - 1968)
Market Index: Equally weighted portfolio of all stocks
on the NYSE.
Outline of the Study
0.3
rj,t = Aj + j rM,t +j,t
0.2 j
0.1
0 rM,t
0 0.2 0.4 0.6
2. Rank order all of the stock betas, and form 20
portfolios. The top 5% with the highest betas are in
portfolio #1, . . . etc. . . the bottom 5% with the
3. smallest
Estimatebetas are of
the beta in each
portfolio #20.
of the portfolios by
regressing portfolio monthly returns against the
market index during the period, 1930 - 1934, (i.e., 60
months):
rp,t
p
rp,t = Ap + p rM,t +p,t
Ap
rM,t
4. For each of the months during the period, 1935-
1938 estimate the ex post SML by regressing
portfolio returns against portfolio betas.
Note: 48 SMLs will be estimated (one for each
month).
rp
a1
rp = a0 + ap +p
a0
p
Summary of Steps 1 Through 4
j1
2 ( j )
rp a 0 a1p a 2 p2 p
rp a 0 a1p a 2 p2 a 3 RVp p
8. For each equation, compute the mean value for
each of the coefficients, and test whether the
means are significantly different from zero:
390
a t
a t 1
390
Results of the FM Study The mean values of the
coefficients are shown below. (*) indicates that the
mean was significantly different from zero.
rp a 0 a1 p p
.0061 * .0085 *
rp a 0 a1 p a 2 p2 p
.0049 * .0105 * - .0008
rp a 0 a1 p a 2 p2 a 3 RVp p
.0020 .0114 * - .0026 .0516
The FM results appeared to be consistent with the
zero beta version of the CAPM:
E(r) E(r)
0.25 CML 0.25
C C SML
M M
E(rM) E(rM)
B B
A
A
E(rz) E(rz)
0 (r) 0
0 0.48 0 0.5 1 1.5
However, given a linear relationship between portfolio
return and beta, it does not necessarily follow that the
market portfolio is efficient. Therefore, we have not
tested the CAPM.
E(r) E(r)
0.25 0.25
M M
E(rM) E(rM)
E(rz) E(rz)
0 (r) 0
0 0.48 0 0.5 1 1.5
For Portfolios
E(r) E(r)
0.25 0.25
M
E(rM) M E(rM)
E(rz) E(rz)
0 (r) 0
0 0.48 0 0.5 1 1.5
Some Recent Controversial Evidence
Fama/French Study
Small firms tend to outperform large firms.
Stocks with low ratios of price to book
value tend to outperform stocks with high
ratios of price to book value.
The relationship between return and beta
was essentially flat to negative.
On the Other Hand . . Some Argued . . .
Fama and French study suffers from
survival bias.
Many stocks with low ratios of price to
book value are in financial stress and
wind up failing. These stocks were
excluded from the Fama and French
data. This produced upward bias in the
performance of low price to book value
stocks as a class.
Still Others Argued . . .