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Equilibrium Cross Section of Returns

João Gomes (), Leonid Kogan () and Lu Zhang ()

Journal of Political Economy, 2003, vol. 111, issue 4, 693-732

Abstract: We construct a dynamic general equilibrium production economy to explicitly link expected stock returns to firm characteristics such as firm size and the book-to-market ratio. Stock returns in the model are completely characterized by a conditional capital asset pricing model (CAPM). Size and book-to-market are correlated with the true conditional market beta and therefore appear to predict stock returns. The cross-sectional relations between firm characteristics and returns can subsist even after one controls for typical empirical estimates of beta. These findings suggest that the empirical success of size and book-to-market can be consistent with a single-factor conditional CAPM model.

Date: 2003
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Handle: RePEc:ucp:jpolec:v:111:y:2003:i:4:p:693-732