Article Critique

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Article Critique
“The Value Premium and the CAPM”
Endri Seiti

Course: Research Methods in Finance and Accounting
Instructor: Dr. Magdy S. Roufaiel

“The Value Premium and the CAPM” paper, written by Eugene Fama and Kenneth French was published in the Journal of Finance in October 2006. Eugene Fama is an American economist, known for his work on portfolio theory and asset pricing and is working as a Professor of Finance at the Chicago University; while Kenneth French is a research associate at the United States’ National Bureau of Economic Research and Professor of Finance at Tuck School of Business.

The paper has three main goals which it attempts to explore; First, to provide a simple picture of how value premiums vary with firm size. Second, to explain if and when CAPM market β’s explain observed value premiums and third, to examine whether in general, variations in β across stocks is related to average returns in the way predicted by the CAPM.

Literature Review:
Other authors’ previous studies related to value premium and the CAPM have revealed that: a) Tim Loughran (“Book-to-market across firm size, exchange and seasonality”, Journal of Finance and Quantitative Analysis, 1997): Contends that value premium is limited to small stocks. b) Andrew Ang & Joseph Chen (“The CAPM over the long run: 1926-2001”, Working Paper, Columbia University, 2005): Contend that CAPM can explain U.S. value premiums. c) Eugene Fama & Kenneth French (“The cross section of expected stock returns”, Journal of Finance, 1992): Contend that there is a value premium in U.S. stock returns for the post 1963 period. d) Eugene Fama & Kenneth French (“Common risk factors in the returns on stocks and bonds”, Journal of Financial Economics, 1993): Contend that the post-1963 value premium is left unexplained by the Capital Asset Pricing Model.

The findings of Fama and French in this paper suggest that: a)...
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