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Some recent observations on the performance and risk characteristics of common stocks

Some recent observations on the performance and risk characteristics of common stocks. Objectives. Compare and contrast the relative performance of cheap and expensive stocks. Definition. Cheap stock = Low market-to-book ratio Expensive stock = High market-to-book ratio. Outline.

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Some recent observations on the performance and risk characteristics of common stocks

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  1. Some recent observations on the performance and risk characteristics of common stocks

  2. Objectives Compare and contrast the relative performance of cheap and expensive stocks.

  3. Definition Cheap stock = Low market-to-book ratio Expensive stock = High market-to-book ratio

  4. Outline • Experiment 1 • Experiment 2 • Discussion

  5. EXPERIMENT 1(Fama and French) Analyze the relationship between average realized returns and market-to-book ratios.

  6. EXPERIMENT 1 Year 1 Rank all stocks according to market-to-book ratio. Divide them into ten groups. At the end of the year calculate the average realized return for each group (portfolio). Year 2 Re-rank all stocks according to market-to-book ratio. Divide them into ten groups. At the end of the year re-calculate the average realized return for each group (portfolio). Repeat this for 30 years

  7. Relationship between market-to-book ratio and average annual return for American stocks.

  8. EXPERIMENT 2 An analysis into the relationship between market risk and market-to-book ratios.

  9. EXPERIMENT 2 Year 1 Rank all stocks according to their last year's beta. At the end of the year, calculate the market-to-book ratios. Year 2 Re-rank all stocks according to their last's year beta. At the end of the year, calculate the market-to-book ratios. Redo this procedure for all 30 years.

  10. Relationship between risk and market-to-book ratio for American stocks

  11. Discussion Experiment 1: Portfolios of cheaper stocks appear to earn higher returns than portfolios of expensive stocks. Experiment 2: Riskier portfolios (in terms of systematic risk) tend to have higher market-to-book ratios, that is, appear to be more expensive.

  12. Question What is then, the observed relationship between risk and return for American stocks?

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