Investments, tenth edition

  Book-to-Market Ratios 

  

Fama and French 

 

31

 

 

 showed that a powerful predic-

tor of returns across securities is the ratio of the book value of the firm’s equity to the 

  

24

 Donald B. Keim, “Size Related Anomalies and Stock Return Seasonality: Further Empirical Evidence,”  Journal 

of Financial Economics  12 (June 1983). 

  

25

 Marc R. Reinganum, “The Anomalous Stock Market Behavior of Small Firms in January: Empirical Tests for 

Tax-Loss Effects,”  Journal of Financial Economics  12 (June 1983). 

  

26

 Marshall E. Blume and Robert F. Stambaugh, “Biases in Computed Returns: An Application to the Size Effect,” 

 Journal of Financial Economics,   1983. 

  

27

 Avner Arbel and Paul J. Strebel, “Pay Attention to Neglected Firms,”  Journal of Portfolio Management,   Winter  1983. 

  

28

 Avner Arbel, “Generic Stocks: An Old Product in a New Package,”  Journal of Portfolio Management,  Summer 1985. 

  

29

 Robert C. Merton, “A Simple Model of Capital Market Equilibrium with Incomplete Information,”  Journal of 

Finance  42 (1987), pp. 483–510. 

  

30

 Yakov Amihud and Haim Mendelson, “Asset Pricing and the Bid–Ask Spread,”  Journal of Financial Econom-

ics  17 (December 1986), pp. 223–50; and “Liquidity, Asset Prices, and Financial Policy,”  Financial Analysts 

Journal  47 (November/December 1991), pp. 56–66. 

 

31

 Eugene F. Fama and Kenneth R. French, “The Cross Section of Expected Stock Returns,”  Journal of Finance  

47 (1992), pp. 427–65.

bod61671_ch11_349-387.indd   368

bod61671_ch11_349-387.indd   368

7/17/13   3:41 PM

7/17/13   3:41 PM

Final PDF to printer

---

  C H A P T E R  

1 1

  The Efficient Market Hypothesis 

369

market value of equity. Fama 

and French stratified firms into 

10 groups according to book-

to-market ratios and examined 

the average monthly rate of 

return of each of the 10 groups. 

 Figure  11.4  is an updated ver-

sion of their results. The decile 

with the highest book-to-market 

ratio had an average annual 

return of 16.87%, while the 

lowest-ratio decile averaged 

only 10.92%. The dramatic 

dependence of returns on book-

to-market ratio is independent 

of beta, suggesting either that 

high book-to-market ratio firms 

are relatively underpriced, or 

that the book-to-market ratio 

is serving as a proxy for a risk 

factor that affects equilibrium 

expected returns.

   

 

In fact, Fama and French 

found that after controlling for 

the size and    book-to-market  effects,      beta seemed to have no power to explain average 

security returns.  

32

   This finding is an important challenge to the notion of rational markets, 

because it seems to imply that a factor that should affect returns—systematic risk—seems 

not to matter, while a factor that should not matter—the book-to-market ratio—seems 

capable of predicting future returns. We will return to the interpretation of this anomaly.