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UNDERSTANDING SIZE AND THE BOOK‐TO‐MARKET RATIO: AN EMPIRICAL EXPLORATION OF BERK'S CRITIQUE
Author(s) -
Fan Xinting,
Liu Ming
Publication year - 2005
Publication title -
journal of financial research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.319
H-Index - 49
eISSN - 1475-6803
pISSN - 0270-2592
DOI - 10.1111/j.1475-6803.2005.00136.x
Subject(s) - economics , market capitalization , market liquidity , econometrics , equity (law) , momentum (technical analysis) , financial economics , market size , monetary economics , stock market , geography , context (archaeology) , archaeology , commerce , political science , law
Because they are scaled by price, the ability of size (i.e., the market capitalization of a firm) and the book‐to‐market equity ratio to determine expected returns may, according to Berk (1995), reflect only a simultaneity bias. The two‐stage least squares approach is used to control for this bias and to investigate the economic meanings of these variables. We discover that size and the book‐to‐market ratio contain distinct and significant components of financial distress, growth options, the momentum effect, liquidity, and firm characteristics. Our findings support Berk in his contention that that size and the book‐to‐market ratio reflect a combination of different economic mechanisms that are misspecified in the expected return process.