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Book-to-Market and Size Effect: Compensations for risks or outcomes of market inefficiencies

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Author

Summary, in English

We employ the optimal orthogonal portfolio approach to investigate if the size and book-to-market effects in US data are related to risk factors beside the market risk. This method enables us to estimate the upper limit of the risk premium, due to observed as well as all possible unobserved factors, which can be derived from a linear asset pricing model. As a corollary, it is possible to divide the observed average asset return into three parts: one explained by the market factor, one due to the unobserved factors, and finally the non-risk-based (NRB) component. Our empirical results confirm the existence of latent risk factors, which cannot be captured by the market index. In particular, the size effect is related to some other background risk factors than the market portfolio, but a large part of observed book-to-market effect has a NRB explanation.

Publishing year

2010

Language

English

Pages

119-136

Publication/Series

European Journal of Finance

Volume

16

Issue

2

Document type

Journal article

Publisher

Taylor & Francis

Topic

  • Economics and Business
  • Economics

Keywords

  • asset pricing
  • orthogonal portfolio
  • CAPM anomalies
  • size effect
  • value
  • effect

Status

Published

ISBN/ISSN/Other

  • ISSN: 1466-4364