One important goal of this study is to find out, whether the most recent data also shows the same tendency as earlier studies of the German market:
A very low relation between beta and average stock returns
A higher relationship between size and average stock returns
An even higher relation between B/M ratio and average stock returns.
In many studies the methodology used to test for the relationship between beta, size, B/M ratio, and stock returns are cross-sectional regressions and two-sorted portfolios. In this study, more weight is put on the ability to predict stock returns by testing these characteristics alone. Usually researchers are interested in the statistical relationship between the characteristics and stock returns. In contrast to this approach, which is especially reasonable for long-term series, this study will focus on the problems with the data and methodology of “anomaly” studies, and will discuss the different economic reasons respective to beta, size, and B/M effects in stock returns. Most of the published studies use long-term series of longer than 30 years, where the stock market returns are quite stable and only small shocks are included.
This thesis is organized as follows: In section 2, findings and economic interpretations in the literature about beta, size and B/M, are discussed. The first findings, especially about size and B/M, are briefly reconsidered and recent developments are presented and further discussed. Section 3 describes the data used for the empirical study and discusses the specialties of the data preparation used, when testing for size and B/M effects. The methodologies and results are then presented in section 4. Concluding remarks are found in section 5.
Table of Contents
1. Introduction
2. Literature Review
2.1. Validity of the CAPM-β
2.2. Size
2.3. Book-to-Market
3. Data
3.1. Data Sources
3.2. Data Preparation
3.3. Data Problems
4. Methodology and Empirical Results
4.1. CAPM-β
4.2. Size
4.3. Book-to-Market
4.4. Cross-Sectional Regressions
5. Conclusions
Research Objectives and Topics
This thesis investigates the explanatory power of beta, company size, and the book-to-market (B/M) ratio in relation to stock returns within the German equity market during the volatile period from 2005 to 2009. The primary research goal is to determine if these characteristics exhibit predictive power for stock returns under the specific market conditions of the recent global financial crisis.
- Empirical analysis of the Capital Asset Pricing Model (CAPM) validity in Germany.
- Examination of the "small-firm effect" and its stability during turbulent market phases.
- Evaluation of the B/M ratio's significance as a predictor of stock returns.
- Methodological assessment of portfolio construction and cross-sectional regressions in short, unstable time frames.
Excerpt from the Book
1. Introduction
The renowned and still popular Capital Asset Pricing Model (CAPM) developed by Sharpe (1964), Lintner (1965), and Black (1972) is the standard Asset Pricing Model for theory and practice. While the first empirical studies which tested for the validity of the CAPM-β and were conducted by, among others, Black, Jensen, and Scholes (1972) and Fama and MacBeth (1973), confirmed the validity of the CAPM-β as significantly related to average stock returns, later studies, which used more recent data could not confirm its validity.
Thus, other models were developed to improve the standard model in order to show a more significant relation between beta and average stock returns. Many different approaches to improve the standard model introduced by Sharpe-Lintner-Black were developed that attempted to uphold the hypothesis of “efficient capital markets”.
But other models were developed that were not closely related to the CAPM. In some cases fundamental or macroeconomic data were used to make up for the CAPM’s lack of explanatory power. Although some of these factors were able to describe security returns, the widely-tested alternative to the standard CAPM version is the extension of the model by both size and book-to-market (B/M) ratio; the Three Factor Model introduced by Fama and French (FF, 1992). For its high explanatory power in many studies of different markets, it was often mentioned as a reasonable extension of the standard CAPM.
Summary of Chapters
1. Introduction: Introduces the standard CAPM model and its limitations, setting the stage for analyzing the additional explanatory power of size and book-to-market factors.
2. Literature Review: Provides an overview of academic discussions regarding the validity of beta, the size effect, and the B/M effect in various international and German equity markets.
3. Data: Details the data sources, preparation process, and potential statistical problems associated with the chosen sample of German stocks.
4. Methodology and Empirical Results: Presents the primary empirical findings using portfolios sorted by beta, size, and B/M, alongside cross-sectional regression analyses.
5. Conclusions: Summarizes the study's findings, highlighting the predictive characteristics of the analyzed factors during the observed 2005-2009 period.
Keywords
CAPM, Beta, German Stock Market, Size Effect, Book-to-Market Ratio, Financial Crisis, Equity Returns, Portfolio Sorting, Cross-Sectional Regression, Market Capitalization, Empirical Finance, Institutional Ownership, Efficient Markets, Small-Firm Premium, Asset Pricing
Frequently Asked Questions
What is the primary subject of this thesis?
This thesis examines the explanatory power of three factors—beta, company size, and the book-to-market ratio—in relation to stock returns in the German equity market.
What are the core research themes covered?
The work focuses on testing the validity of the Capital Asset Pricing Model (CAPM) and analyzing whether market anomalies like the size and B/M effects persist in the German market.
What is the main research question or goal?
The study aims to determine if the mentioned characteristics can effectively predict stock returns during a very short and turbulent period (2005-2009) impacted by the global financial crisis.
Which scientific methodology is employed?
The author uses portfolio construction methods and cross-sectional regressions to analyze the relationship between stock returns and specific firm characteristics.
What does the main part of the thesis cover?
The main section covers the collection and preparation of data, the empirical testing of beta-sorted, size-sorted, and B/M-sorted portfolios, and multivariate regression models.
Which keywords best characterize this work?
Key terms include CAPM, German Stock Market, Size Effect, Book-to-Market Ratio, and Empirical Finance.
How does the financial crisis affect the study's findings?
The crisis period introduces extreme volatility, which complicates the detection of long-term trends and leads to discrepancies when compared with earlier studies that relied on more stable, longer time series.
Why are portfolios constructed using specific market segments?
The author segments the data to ensure empirical relevance and to address issues like institutional ownership and different accounting standards relevant to the German market.
What conclusion does the author reach regarding the CAPM?
The findings reinforce the notion that the CAPM-β has limited explanatory power, especially when market conditions are turbulent, necessitating the exploration of additional risk factors.
Does the size effect persist in this analysis?
The study finds that the traditional size effect is inconsistent over the analyzed period, suggesting that it is highly sensitive to the chosen timeframe and market conditions.
- Quote paper
- David Bosch (Author), 2010, Size and Book-to-Market Effects in the German Stock Market, 2005-2009, Munich, GRIN Verlag, https://www.grin.com/document/364783
