The book-to-market equity ratio as a proxy for risk: evidence from Australian markets

Michael Dempsey
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Michael Dempsey: Department of Accounting and Finance, Faculty of Business and Economics, michael.dempsey@buseco.monash.edu.au

Australian Journal of Management, 2010, vol. 35, issue 1, 7-21

Abstract: Crucial to the interpretation of the Fama and French three-factor model is the question of whether the book-to-market equity ratio should be assigned as a ‘risk-based,’ as opposed to a ‘mispricing’ explanation of share price formation. In the context of Australian stock markets, we examine the role of the book-to-market equity ratio in the formation of stock returns. Notwithstanding the distinctive characteristics of Australian markets, our findings are complementary with findings for U.S. stocks. We succeed in revealing a strong association between stock returns and the firm’s book-to-market equity ratio, and find strong evidence that the association derives from the book-to-market ratio’s absorption of the implications of market leverage as a risk factor. In addition, we determine evidence of mispricing as contributing to the formation of market leverage itself.

Date: 2010
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Persistent link: https://EconPapers.repec.org/RePEc:sae:ausman:v:35:y:2010:i:1:p:7-21

DOI: 10.1177/0312896209351451

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