Kenneth R. French

• Dartmouth College

Variation in monthly metro area house prices unrelated to expected rents clouds the information about future rents in price-rent ratios and lagged changes in house prices. The variation in house prices unrelated to expected rents is, however, correlated across areas, and the problem is mitigated by measuring rent growth regression variables net of...

Value premiums, which we define as value portfolio returns in excess of market portfolio returns, are on average much lower in the second half of the July 1963–June 2019 period. But the high volatility of monthly premiums prevents us from rejecting the hypothesis that expected premiums are the same in both halves of the sample. Regressions that for...

We use the cross-section regression approach of Fama and MacBeth (1973) to construct cross-section factors corresponding to the time-series factors of Fama and French (2015). Time-series models that use only cross-section factors provide better descriptions of average returns than time-series models that use time-series factors. This is true when w...

Value premiums, which we define as value portfolio returns in excess of market portfolio returns, are on average much lower in the second half of the July 1963-June 2019 period. But the high volatility of monthly premiums prevents us from rejecting the hypothesis that expected premiums are the same in both halves of the sample. Regressions that for...

We use bootstrap simulations to examine the properties of long-horizon U.S. stock market returns. We document the rate at which continuously compounded market returns converge toward normal distributions as we extend the horizon from 1 month to 30 years, and the rate at which dollar payoffs converge toward lognormal. We also verify that, though lar...

The average monthly premium of the Market return over the one-month T-bill return is substantial, as are average premiums of value and small stocks over Market. As the return horizon increases, premium distributions become more disperse, but they move to the right (toward higher values) faster than they become more disperse. There is, however, some...

Our goal is to develop insights about the maximum squared Sharpe ratio for model factors as a metric for ranking asset pricing models. We consider nested and non-nested models. The nested models are the capital asset pricing model, the three-factor model of Fama and French (1993), the five-factor extension in Fama and French (2015), and a six-facto...

The average monthly premium of the Market return over the one-month T-bill return is substantial, as are average premiums of value and small stocks over Market. As the return horizon increases, premium distributions become more disperse, but they move to the right (toward higher values) faster than they become more disperse. There is, however, some...

Average stock returns for North America, Europe, and Asia Pacific increase with the book-to-market ratio (B/M) and profitability and are negatively related to investment. For Japan, the relation between average returns and B/M is strong, but average returns show little relation to profitability or investment. A five-factor model that adds profitabi...

A five-factor model that adds profitability (RMW) and investment (CMA) factors to the three-factor model of Fama and French (1993) suggests a shared story for several average-return anomalies. Specifically, positive exposures to RMW and CMA (stock returns that behave like those of profitable firms that invest conservatively) capture the high averag...

Variables with strong marginal explanatory power in cross-section asset pricing regressions typically show less power to produce increments to average portfolio returns, for two reasons. (1) Adding an explanatory variable can attenuate the slopes in a regression. (2) Adding a variable with marginal explanatory power always attenuates the values of...

Average stock returns for North America, Europe, and Asia Pacific increase with the book-to-market ratio (B/M) and profitability and are negatively related to investment. For Japan, the relation between average returns and B/M is strong, but average returns show little relation to profitability or investment. A five-factor model that adds profitabi...

A five-factor model directed at capturing the size, value, profitability, and investment patterns in average stock returns performs better than the three-factor model of Fama and French (FF, 1993). The five-factor model's main problem is its failure to capture the low average returns on small stocks whose returns behave like those of firms that inv...

Variables with strong marginal explanatory power in cross-section asset pricing regressions typically show less power to produce increments to average portfolio returns, for two reasons. (1) Adding an explanatory variable can attenuate the slopes in a regression. (2) Adding a variable with marginal explanatory power always attenuates the values of...

A five-factor model that adds profitability (RMW) and investment (CMA) factors to the three-factor model of Fama and French (1993) suggests a shared story for several average-return anomalies. Specifically, positive exposures to RMW and CMA (returns that behave like those of the stocks of profitable firms that invest conservatively) capture the hig...

To address the moral hazard problem that can motivate bank executives to take excessive risks and to fail to raise capital when needed, a group of 13 distinguished financial economists recommends that systemically important financial institutions be required to issue contingent convertible debt (CoCos) and to hold back a substantial share—as much a...

UBS recently announced it would pay part of the bonuses of 6,500 highly compensated employees with bonds that would be forfeited if the bank does not meet its capital requirements. This memo underscores the benefits of contingent deferred compensation and makes recommendations for how such compensation should be structured at systemically important...

A five-factor model directed at capturing the size, value, profitability, and investment patterns in average stock returns performs better than the three-factor model of Fama and French (FF 1993). The five-factor model’s main problem is its failure to capture the low average returns on small stocks whose returns behave like those of firms that inve...

We examine three pairs of cross-section regressions that test predictions of the tradeoff model, the pecking order model, and models that center on market conditions. The regressions examine (i) the split of new outside financing between share issues and debt, (ii) the split of debt financing between short-term and long-term, and (iii) the split of...

In the four regions (North America, Europe, Japan, and Asia Pacific) we examine, there are value premiums in average stock returns that, except for Japan, decrease with size. Except for Japan, there is return momentum everywhere, and spreads in average momentum returns also decrease from smaller to bigger stocks. We test whether empirical asset pri...

The current stable-NAV model for prime money market funds exposes fund investors and systemically important borrowers to runs like those that occurred after the failure of Lehman in September 2008. This working paper, by the Squam Lake Group, argues that, to reduce this risk, funds should have either floating NAVs or buffers provided by their spons...

The aggregate portfolio of actively managed U.S. equity mutual funds is close to the market portfolio, but the high costs of active management show up intact as lower returns to investors. Bootstrap simulations suggest that few funds produce benchmark-adjusted expected returns sufficient to cover their costs. If we add back the costs in fund expens...

In these excerpts from The Squam Lake Report, fifteen distinguished economists analyze where the global financial system failed, and how such failures might be prevented (or at least their damage better contained) in the future. Although there were many contributing factors to the crisis—including “agency” problems throughout the financial system a...

The book-to-market ratio (B/M) is a noisy measure of expected stock returns because it also varies with expected cashflows. Our hypothesis is that the evolution of B/M, in terms of past changes in book equity and price, contains independent information about expected cashflows that can be used to improve estimates of expected returns. The tests sup...

We extend the evidence of Fama and French (1995) on the post-1962 profitability and equity financing of firms in different style groups (small versus big, value versus growth) to 1926-2006. The emphasis is on whether equity-financed investment varies with cashflows and price-to-book ratios in ways that support or violate the pecking order model of...

I compare the fees, expenses, and trading costs society pays to invest in the U.S. stock market with an estimate of what would be paid if everyone invested passively. Averaging over 1980 to 2006, I find investors spend 0.67% of the aggregate value of the market each year searching for superior returns. Society's capitalized cost of price discovery...

I compare the fees, expenses, and trading costs society pays to invest in the U.S. stock market with an estimate of what would be paid if everyone invested passively. Averaging over 1980-2006, I find investors spend 0.67% of the aggregate value of the market each year searching for superior returns. Society's capitalized cost of price discovery is...

The anomalous returns associated with net stock issues, accruals, and momentum are pervasive; they show up in all size groups (micro, small, and big) in cross-section regressions, and they are also strong in sorts, at least in the extremes. The asset growth and profitability anomalies are less robust. There is an asset growth anomaly in average ret...

Average returns on value and growth portfolios are broken into dividends and three sources of capital gain: (1) growth in book equity, primarily from earnings retention, (2) convergence in price-to-book ratios (P/Bs) from mean reversion in profitability and expected returns, and (3) upward drift in P/B during 1927-2006. The capital gains of value s...

Four decades after its advent, the capital assets pricing model proposed by Nobel Prize laureate William Sharpe and by John Lintner, known as CAPM, remains the most widely used model in estimating fi rms' cost of capital and valuing portfolios. This is due to the model's predictive power for risk and risk-return ratios. The purpose of this article...

Migration of stocks across size and value portfolios contributes to the size and value premiums in average stock returns. The size premium is almost entirely generated by the small-capitalization stocks that earn extreme positive returns and thus become big-cap stocks. The value premium comes from (1) value stocks that improve in type because their...

We study put option sales undertaken by corporations during their repurchase programs. Put sales' main theoretical motivation is market timing, providing an excellent framework for studying whether security issues reflect managers' ability to identify mispricing. Our evidence is that these bets reflect timing ability, and are not simply a result of...

We break average returns on value and growth portfolios into dividends and three sources of capital gain, (i) growth in book equity primarily due to earnings retention, (ii) convergence in price-to-book ratios (P/B) due to mean reversion in profitability and expected returns, and (iii) upward drift in P/B during 1927-2006. The capital gains of valu...

Valuation theory says that expected stock returns are related to three variables: the book-to-market equity ratio (B-t/M-t), expected profitability, and expected investment. Given B-t/M-t and expected profitability, higher expected rates of investment imply lower expected returns. But controlling for the other two variables, more profitable firms h...

We examine (1) how value premiums vary with firm size, (2) whether the CAPM explains value premiums, and (3) whether, in general, average returns compensate β in the way predicted by the CAPM. Loughran's (1997) evidence for a weak value premium among large firms is special to 1963 to 1995, U.S. stocks, and the book-to-market value-growth indicator....

We study how migration of firms across size and value portfolios contributes to the size and value premiums in average stock returns. The size premium is almost entirely due to the small stocks that earn extreme positive returns and as a result become big stocks. The value premium has three sources: (i) value stocks that improve in type either beca...

We examine (1) how value premiums vary with firm size, (2) whether the CAPM explains value premiums, and (3) whether, in general, average returns compensate β in the way predicted by the CAPM. Loughran's (1997) evidence for a weak value premium among large firms is special to 1963 to 1995, U.S. stocks, and the book-to-market value-growth indicator....

Standard asset pricing models assume that: (i) there is complete agreement among investors about probability distributions of future payoffs on assets; and (ii) investors choose asset holdings based solely on anticipated payoffs; that is, investment assets are not also consumption goods. Both assumptions are unrealistic. We provide a simple framewo...

Financing decisions seem to violate the central predictions of the pecking order model about how often and under what circumstances firms issue equity. Specifically, most firms issue or retire equity each year, and the issues are on average large and not typically done by firms under duress. We estimate that during 1973–2002, the year-by-year equit...

Standard asset pricing models assume that (i) there is complete agreement among investors about probability distributions of future payoffs on assets, and (ii) investors choose asset holdings based solely on anticipated payoffs; that is, investment assets are not also consumption goods. Both assumptions are unrealistic. We provide a simple framewor...

Firm investment activity and firm characteristics, particularly the market-to-book ratio or q, are functions of the state of the economy and therefore contain information about the dynamic behavior of stock returns. This paper develops a model of a produc-tion economy in which real investment is irreversible and subject to convex adjustment costs....

Valuation theory says that expected stock returns are related to three variables: the book-to-market equity ratio (B/M), expected profitability, and expected investment. Given B/M and expected profitability, higher rates of investment imply lower expected returns. But controlling for the other two variables, more profitable firms have higher expect...

The capital asset pricing model (CAPM) of William Sharpe (1964) and John Lintner (1965) marks the birth of asset pricing theory (resulting in a Nobel Prize for Sharpe in 1990). Before their breakthrough, there were no asset pricing models built from first principles about the nature of tastes and investment opportunities and with clear testable pre...

http:/ssrn.com/abstract=440920 First draft: August2003 Not for quotation

The class of firms that obtain public equity financing expands dramatically in the 1980s and 1990s. The number of new firms listed on major U.S. stock markets jumps from 156 per year for 1973–1979 to 549 per year for 1980–2001. The characteristics of new lists also change. The cross section of profitability becomes progressively more left skewed, a...

We estimate the equity premium using dividend and earnings growth rates to measure the expected rate of capital gain. Our estimates for 1951 to 2000, 2.55 percent and4.32 percent, are much lower than the equity premium produced by the average stock return,7.43 percent. Our evidence suggests that the high average return for 1951 to 2000 is due to a...

Confirming predictions shared by the trade-off and pecking order models, more profitable firms and firms with fewer investments have higher dividend payouts. Confirming the pecking order model but contradicting the trade-off model, more profitable firms are less levered. Firms with more investments have less market leverage, which is consistent wit...

After 1979, the rate at which new firms are listed on the major U.S. stock exchanges increases sharply, asset growth rates of new lists are high, but their profitability declines and remains low for at least five years after listing. New lists also become less likely to survive, primarily because of delisting for poor performance. Overall, market p...

The proportion of U.S. firms paying dividends drops sharply during the 1980s and 1990s. Among NYSE, AMEX, and Nasdaq firms, the proportion of dividend payers falls from 66.5% in 1978 to only 20.8% in 1999. The decline is due in part to an avalanche of new listings that tilts the population of publicly traded firms toward small firms with low profit...

We test the dividend and leverage predictions of the tradeoff and pecking order models. As both models predict, more profitable firms have higher long-term dividend payouts, and firms with more investments have lower payouts. Confirming the pecking order model but contradicting the tradeoff model, more profitable firms are less levered. Firms with...

The percent of firms paying cash dividends falls from 66.5 in 1978 to 20.8 in 1999. The decline is due in part to the changing characteristics of publicly traded firms. Fed by new lists, the population of publicly traded firms tilts increasingly toward small firms with low profitability and strong growth opportunities -- characteristics typical of...

There is a strong presumption in economics that, in a competitive environment, profitability is mean reverting. We provide corroborating evidence. In a simple partial adjustment model, the estimated rate of mean reversion is about 38% per year. But a simple partial adjustment model with a uniform rate of mean reversion misses rich nonlinear pattern...

The value premium in U.S. stock returns is robust. The positive relation between average return and book-to-market equity is as strong for 1929 to 1963 as for the subsequent period studied in previous papers. A three-factor risk model explains the value premium better than the hypothesis that the book-to-market characteristic is compensated irrespe...

There is a strong presumption in economics that, in a competitive environment, profitability is mean reverting. We provide corroborating evidence. In a simple partial adjustment model, the estimated rate of mean reversion is about 38% per year. But a simple partial adjustment model with a uniform rate of mean reversion misses rich nonlinear pattern...

We estimate the equity premium using dividend and earnings growth rates to measure the expected rate of capital gain. Our estimates for 1951 to 2000, 2.55 percent and 4.32 percent, are much lower than the equity premium produced by the average stock return, 7.43 percent. Our evidence suggests that the high average return for 1951 to 2000 is due to...

We estimate the internal rates of return earned by nonfinancial firms on (i) the initial market values of their securities and (ii) the cost of their investments, The return on value is an estimate of the overall corporate cost of capital. The estimate of the real cost of capital for 1950-96 is 5.95 percent. The real return on cost is larger, 7.38...

The value premium in U.S. stocks returns is robust. The positive relation between average return and book-to-market equity (BE/ME) is as strong for 1929-63 as for the subsequent period studied in previous papers. Like others, we also find a size premium in stock returns. Small stocks have higher average returns than big stocks. The size premium is,...

We estimate the internal rates of return earned by nonfinancial firms on (i) the initial market values of their securities and (ii) the cost of their investments. The return on value is an estimate of the overall corporate cost of capital. The estimate of the real cost of capital for 1950-96 is 5.95 percent. The real return on cost is larger, 7.38...

Value stocks have higher returns than growth stocks in markets around the world. For the period 1975 through 1995, the difference between the average returns on global portfolios of high and low book-to-market stocks is 7.68 percent per year, and value stocks outperform growth stocks in twelve of thirteen major markets. An international capital ass...

We use cross-sectional regressions to study how a firm's value is related to dividends and debt. With a good control for profitability, the regressions can measure how the taxation of dividends and debt affects firm value. Simple tax hypotheses say that value is negatively related to dividends and positively related to debt. We find the opposite. W...

Estimates of the cost of equity for industries are imprecise. Standard errors of more than 3.0% per year are typical for both the CAPM and the three-factor model of Fama and French (1993). These large standard errors are the result of(i) uncertainty about true factor risk premiums and (ii) imp ecise estimates of the loadings of industries on the ri...

We estimate that the average value of a dollar invested in the U.S. corporate sector is $1.18. When we delete utilities and current assets, where opportunities for value added seem limited, the estimate jumps to $1.68. We use cross-section regressions to study how value is related to dividends and debt. The regressions can potentially identify tax...

Previous work shows that average returns on common stocks are related to firm characteristics like size, earnings/price, cash flow/price, book-to-market equity, past sales growth, long-term past return, and short-term past return. Because these patterns in average returns apparently are not explained by the CAPM, they are called anomalies. We find...

Previous work shows that average returns on common stocks are related to firm characteristics like size, earnings/price, cash flow/price, book-to-market equity, past sales growth, long-term past return, and short-term past return. Because these patterns in average returns apparently are not explained by the capital asset pricing model, (CAPM), they...

Kothari, Shanken, and Sloan (1995) claim that betas from annual returns produce a stronger positive relation between beta and average return than betas from monthly returns. They also contend that the relation between average return and book-to-market equity (BE/ME) is seriously exaggerated by survivor bias. We argue that survivor bias does not exp...

This paper uses a methodology robust to recent criticisms of standard long-horizon event study tests to show that bidders in mergers underperform while bidders in tender offers overperform in the three years after the acquisition. However, the long-term underperformance of acquiring firms in mergers is predominantly caused by the poor post-acquisit...

In the early 1980s, R.F. Engle pioneered the econometric technique of Auto-Regressive Conditional Heteroskedasticity (ARCH), which has subsequently generated a very considerable literature. This collection brings together the leading papers which have shaped ARCH research from its inception to the latest developments. Papers present both theory and...

The authors study whether the behavior of stock prices, in relation to size and book-to-market equity (BE/ME), reflects the behavior of earnings. Consistent with rational pricing, high BE/ME signals persistent poor earnings and low BE/ME signals strong earnings. Moreover, stock prices forecast the reversion of earnings growth observed after firms a...

This paper identifies five common risk factors in the returns on stocks and bonds. There are three stock-market factors: an overall market factor and factors related to firm size and book-to-market equity. There are two bond-market factors, related to maturity and default risks. Stock returns have shared variation due to the stock-market factors, a...

Two easily measured variables, size and book-to-market equity, combine to capture the cross-sectional variation in average stock returns associated with market "beta", size, leverage, book-to-market equity, and earnings-price ratios. Moreover, when the tests allow for variation in "beta" that is unrelated to size, t he relation between market "beta...

ABSTRACT Two easily measured variables, size and book-to-market equity, combine to capture the cross-sectional variation in average stock returns associated with market {3, size, leverage, book-to-market equity, and earnings-price ratios. Moreover, when the tests allow for variation in {3 that is unrelated to size, the relation between market {3 an...

At the end of 1989, Japanese investors held just over 1% of the U.S. stock market, while U.S. investors held less than 1% of the Tokyo market. This pattern of very limited cross-holding has persisted for nearly two decades, despite the diversification gains from cross-border investment. None of the standard explanations for limited international eq...

The difference between reported price-earnings ratios in the United States and Japan is not as puzzling as it appears at first glance. Nearly half the disparity is caused by differences in accounting practices with respect to consolidation of earnings from subsidiaries and depreciation of fixed assets. If Japanese firms used U.S. accounting rules,...

Business cycles in different regions of the United States tend to synchronize. This study investigates the reasons behind this synchronization of business cycles and the consequent formation of a national business cycle. Trade between regions may not be strong enough for one region to "drive" business cycle fluctuations in another region. This stud...

I modify the uniform-price auction rules in allowing the seller to ration bidders. This allows me to provide a strategic foundation for underpricing when the seller has an interest in ownership dispersion. Moreover, many of the so-called "collusive-seeming" equilibria disappear.

Expected returns on common stocks and long-term bonds contain a term or maturity premium that has a clear business-cycle pattern (low near peaks, high near troughs). Expected returns also contain a risk premium that is related to longer-term aspects of business conditions. The variation through time in this premium is stronger for low-grade bonds t...

The power of dividend yields to forecast stock returns, measured by regression R2, increases with the return horizon. We offer a two-part explanation. (1) High autocorrelation causes the variance of expected returns to grow faster than the return horizon. (2) The growth of the variance of unexpected returns with the return horizon is attenuated by...

A slowly mean-reverting component of stock prices tends to induce negative autocorrelation in returns. The autocorrelation is weak for the daily and weekly holding periods common in market efficiency tests but stronger for long-horizon returns. In tests for the 1926-85 period, large negative autocorrelations for return horizons beyond a year sugges...

The theory of storage says that the marginal convenience yield on inventory falls at a decreasing rate as inventory increases. The authors test this hypothesis by examining the relative variation of spot and futures prices for metals. As the hypothesis implies, futures prices are less variable than spot prices when inventory is low, but spot and fu...

Kenneth French believes that neither investor panic nor a breakdown of market mechanisms on October 19 drove prices to an irrationally low level. Rather, the crash may have been the response of an efficient market to news about expected future cash flows or returns. French theorizes that prices were irrationally high before the crash, that investor...