Written by two experts in the field (including a renowned Nobel Prize Laureate), this book represents an up-to-date compilation of empirical asset pricing theory and their techniques and application keeping emphasis throughout on empirical research and findings. Preface ix I Statistical Methodologies 1 1 Preliminaries 3 1.1 Sample 3 1.2 Winsorization and Truncation 5 1.3 Newey and West (1987) Adjustment 6 1.4 Summary 8 2 Summary Statistics 11 2.1 Implementation 11 2.1.1 Periodic Cross-Sectional Summary Statistics 12 2.1.2 Average Cross-Sectional Summary Statistics 14 2.2 Presentation and Interpretation 15 2.3 Summary 17 3 Correlation 19 3.1 Implementation 20 3.1.1 Periodic Cross-Sectional Correlations 20 3.1.2 Average Cross-Sectional Correlations 21 3.2 Interpreting Correlations 21 3.3 Presenting Correlations 25 3.4 Summary 25 4 Persistence Analysis 29 4.1 Implementation 29 4.1.1 Periodic Cross-Sectional Persistence 30 4.1.2 Average Cross-Sectional Persistence 31 4.2 Interpreting Persistence 31 4.3 Presenting Persistence 35 4.4 Summary 36 5 Portfolio Analysis 39 5.1 Univariate Portfolio Analysis 40 5.1.1 Breakpoints 40 5.1.2 Portfolio Formation 44 5.1.3 Average Portfolio Values 45 5.1.4 Summarizing the Results 48 5.1.5 Interpreting the Results 51 5.1.6 Presenting the Results 52 5.1.7 Analyzing Returns 55 5.2 Bivariate Independent-Sort Analysis 59 5.2.1 Breakpoints 60 5.2.2 Portfolio Formation 63 5.2.3 Average Portfolio Values 64 5.2.4 Summarizing the Results 68 5.2.5 Interpreting the Results 68 5.2.6 Presenting the Results 72 5.3 Bivariate Dependent-Sort Analysis 77 5.3.1 Breakpoints 78 5.3.2 Portfolio Formation 80 5.3.3 Average Portfolio Values 80 5.3.4 Summarizing the Results 83 5.3.5 Interpreting the Results 86 5.3.6 Presenting the Results 86 5.4 Independent versus Dependent Sort 90 5.5 Trivariate-Sort Analysis 93 5.6 Summary 93 6 Fama and MacBeth Regression Analysis 97 6.1 Implementation 97 6.1.1 Periodic Cross-Sectional Regressions 98 6.1.2 Average Cross-Sectional Regression Results 99 6.2 Interpreting FM Regressions 103 6.3 Presenting FM Regressions 105 6.4 Summary 107 II The Cross-Section of Stock Returns 111 7 The CRSP Sample and Market Factor 113 7.1 The U.S. Stock Market 113 7.1.1 The CRSP U.S-based Common Stock Sample 114 7.1.2 Composition of the CRSP Sample 115 7.2 Stock Returns and Excess Returns 121 7.2.1 CRSP Sample (1963-2012) 124 7.3 The Market Factor 126 7.4 The CAPM Risk Model 130 7.5 Summary 131 8 Beta 135 8.1 Calculating Beta 136 8.2 Summary Statistics 138 8.3 Correlations 140 8.4 Persistence 142 8.5 Beta and Stock Returns 144 8.5.1 Portfolio Analysis 145 8.5.2 Fama-MacBeth Regression Analysis 150 8.6 Summary 153 9 The Size Effect 157 9.1 Calculating Market Capitalization 158 9.2 Summary Statistics 161 9.3 Correlations 163 9.4 Persistence 164 9.5 Size and Stock Returns 165 9.5.1 Univariate Portfolio Analysis 166 9.5.2 Bivariate Portfolio Analysis 171 9.5.3 Fama-MacBeth Regression Analysis 179 9.6 The Size Factor 182 9.7 Summary 185 10 The Value Premium 189 10.1 Calculating Book-to-Market Ratio 191 10.2 Summary Statistics 195 10.3 Correlations 196 10.4 Persistence 198 10.5 Book-to-Market Ratio and Stock Returns 199 10.5.1 Univariate Portfolio Analysis 200 10.5.2 Bivariate Portfolio Analysis 202 10.5.3 Fama-MacBeth Regression Analysis 211 10.6 The Value Factor 212 10.7 The Fama and French Three-Factor Model 216 10.8 Summary 216 11 The Momentum Effect 223 11.1 Measuring Momentum 224 11.2 Summary Statistics 225 11.3 Correlations 227 11.4 Momentum and Stock Returns 227 11.4.1 Univariate Portfolio Analysis 228 11.4.2 Bivariate Portfolio Analysis 236 11.4.3 Fama-MacBeth Regression Analysis 249 11.5 The Momentum Factor 252 11.6 The Fama, French, and Carhart Four-Factor Model 256 11.7 Summary 256 12 Short-Term Reversal 263 12.1 Measuring Short-Term Reversal 264 12.2 Summary Statistics 264 12.3 Correlations 264 12.4 Reversal and Stock Returns 265 12.4.1 Univariate Portfolio Analysis 265 12.4.2 Bivariate Portfolio Analyses 269 12.5 Fama-MacBeth Regressions 281 12.6 The Reversal Factor 286 12.7 Summary 290 13 Liquidity 293 13.1 Measuring Liquidity 295 13.2 Summary Statistics 297 13.3 Correlations 298 13.4 Persistence 301 13.5 Liquidity and Stock Returns 303 13.5.1 Univariate Portfolio Analysis 303 13.5.2 Bivariate Portfolio Analysis 308 13.5.3 Fama-MacBeth Regression Analysis 319 13.6 Liquidity Factors 326 13.6.1 Stock-Level Liquidity 328 13.6.2 Aggregate Liquidity 329 13.6.3 Liquidity Innovations 330 13.6.4 Traded Liquidity Factor 331 13.7 Summary 335 14 Skewness 341 14.1 Measuring Skewness 343 14.2 Summary Statistics 345 14.3 Correlations 347 14.3.1 Total Skewness 347 14.3.2 Co-Skewness 351 14.3.3 Idiosyncratic Skewness 352 14.3.4 Total Skewness, Co-Skewness, and Idiosyncratic Skewness 353 14.3.5 Skewness and Other Variables 354 14.4 Persistence 357 14.4.1 Total Skewness 359 14.4.2 Co-Skewness 360 14.4.3 Idiosyncratic Skewness 362 14.5 Skewness and Stock Returns 364 14.5.1 Univariate Portfolio Analysis 364 14.5.2 Fama-MacBeth Regressions 373 14.6 Summary 380 15 Idiosyncratic Volatility 387 15.1 Measuring Total Volatility 389 15.2 Measuring Idiosyncratic Volatility 390 15.3 Summary Statistics 391 15.4 Correlations 393 15.5 Persistence 403 15.6 Idiosyncratic Volatility and Stock Returns 406 15.6.1 Univariate Portfolio Analysis 407 15.6.2 Bivariate Portfolio Analysis 414 15.6.3 Fama-MacBeth Regression Analysis 422 15.6.4 Cumulative Returns of IdioV olFF;1M Portfolio 431 15.7 Summary 432 16 Liquid Samples 437 16.1 Samples 438 16.2 Summary Statistics 438 16.3 Correlations 443 16.4 Persistence 445 16.5 Expected Stock Returns 448 16.5.1 Univariate Portfolio Analysis 450 16.5.2 Fama-MacBeth Regression Analysis 459 16.6 Summary 462 17 Option-Implied Volatility 467 17.1 Options Sample 469 17.2 Option-Based Variables 470 17.2.1 Predictive Variables 470 17.2.2 Option Returns 473 17.2.3 Additional Notes 474 17.3 Summary Statistics 475 17.4 Correlations 478 17.5 Persistence 480 17.6 Stock Returns 481 17.6.1 IV olSpread, IV olSkew, and V ol1M IV ol 481 17.6.2 IV olC and IV olP 486 17.7 Option Returns 495 17.8 Summary 501 18 Other Stock Return Predictors 507 18.1 Asset Growth 508 18.2 Investor Sentiment 509 18.3 Investor Attention 511 18.4 Differences of Opinion 512 18.5 Protability and Investment 512 18.6 Lottery Demand 513