Does Noise Create the Size and Value Effects?
Standard asset pricing models do not generate the cross-sectional variation in expected returns documented in Fama and French (1992). In this paper, we show that noise, a random difference between the price and value, can create signifieant cross-sectional variations in both unconditional and conditional expected returns. For example, the unconditional expected return depends on idiosyncratic volatility, the volatility and the mean reversion coeffient of the price noise and price-dividend ratio, in addition to beta. More importantly, we show that the cross-sectional variation in expected returns conditional on price and price-ratios can be generated by realizations of the price noise and thus exists even in the absence of the parameter variations. We show that stocks with lower prices or lower price ratios have higher expected returns. These higher expected returns are not compensation for risk but are generated because a stock with a low price or a price-ratio is more likely to have a negative price noise thus to be undervalued. Our model captures the basic intuition that value stocks are, in fact, bargains on average. Fama and French (1992) use the matrix of expected returns conditional on size- value deciles as a forceful and informative demonstration of size and value effects. This matrix can be computed in closed form using our model and, for plausible parameters, is similar to its empirical counterpart (Table V of Fama and French). In our model, small and value stocks have slightly higher betas and positive alphas. Our study suggests that noise creates the size and value effect.
Robert Arnott Jason Hsu Jun Liu Harry Markowitz
Research Affliates, LLC Research Affiliates,LLC and University of California, Irvine University of California, San Diego
国际会议
成都
英文
1-46
2007-07-09（万方平台首次上网日期，不代表论文的发表时间）