Are Two Factors Enough? The U.K. Evidence Author(s): George Leledakis and Ian Davidson Reviewed work(s): Source: Financial Analysts Journal, Vol. 57, No. 6 (Nov. - Dec., 2001), pp. 96-105 Published by: CFA Institute Stable URL: http://www.jstor.org/stable/4480359 . Accessed: 13/03/2013 15:30 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp
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and IanDavidson George Leledakis
valueof equityto market that Somestudiesin the1990sdocumented book valueof equity(MVE)capture valueof equity(BV/MV)and the market in in returns theU.S.market the1963of variation stock thecross-sectional that however, two othervariablesargued, researchers Other 90 period. ratio ratio thesales-to-price (S/P)andthedebt-to-equity (D/E)-have more thanBV/MVandMVE.Theevidence stockreturns powerfor explanatory that data,indicates S/P and StockExchange fromLondon in this article, the the absorb rolesofBV/MVandMVEin explaining DIEdonotentirely We in stockreturns theU.K.market. didfindthat of cross-section average of the beyond contribution BV/MV power explanatory S/P hassignificant by powerof DIEis captured S/P. andMVE,buttheexplanatory
studies have documented that stock returns can be predicted by company-specificvariables in a manner inconsistentwith the acceptedparadigms of modern finance-in particular, the capital asset pricing model of Sharpe (1964) and The influentialwork of Fama and Lintner(1965).1 French (1992) on the determinants of the crosssection of average stock returnshas given focus to Famaand Frenchfound thatthe ratio the literature. of book value of equity to marketvalue of equity (BV/MV)and the marketvalue of equity (MVE)as a proxyof the companysize sufficeto explaincrosssectionalvariationin stock returnsin the U.S. market in the 1963-90 period. Barbee,Mukherji,and Raines (1996) argued, however, that two other variables-the sales-to-price ratio (S/P) and the ratio(D/E)-have moreexplanatory debt-to-equity power for stock returnsthan BV/MV and MVE.2 Why the company-specific variables should predict stock returnsis the subjectof controversy. Some believe that these variables are proxies for unobservablecommon risk factorsthat are consistent with rational asset pricing (e.g., Fama and French1993, 1995, 1996a).Others argue that such variables may be used to find securities that are systematically mispriced by the market (e.g., Lakonishok, Shleifer, and Vishny 1994; Haugen and Baker1996;Daniel and Titman1997).Still others arguethatthe observedpredictiverelationships arelargelythe resultof data-snoopingbias (e.g.,Lo
is fellowandIan Davidson Leledakis a research George Busiat offinancialmanagement Warwick is professor UnitedKingdom. of University Warwick, nessSchool, 96
and MacKinlay1990;Black1993;MacKinlay1995; White 2000) and survivorship bias (e.g., Kothari, Shanken,and Sloan 1995;Brown and Goetzmann 1995;Brown,Goetzmann,and Ross 1995). A numberof studies have helped mitigateconcerns about data snooping by using out-of-sample data (e.g., Chan, Hamao, and Lakonishok 1991; Famaand French Capaul,Rowley,and Sharpe1993; Coggin,and Doukas1998),data Arshanapalli, 1998; fromdifferenttime periods (e.g.,Davis 1994;Davis, Fama, and French 2000), or data from a holdout...