Equilibrium “Anomalies”


  • Michael F. Ferguson,

  • Richard L. Shockley

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    • Ferguson is in the College of Business at the University of Cincinnati and Shockley is in the Kelley School of Business at Indiana University. For their very helpful comments and suggestions we thank Tom Arnold, Jonathan Berk, Michael Brennan, Bob Dittmar, Phil Dybvig, Mark Ferguson, Steve Jones, Darius Miller, Richard Roll, Richard Stanton, Chuck Trzcinka, two anonymous referees, Journal of Finance Editors René Stulz and Richard Green, and seminar participants at the Board of Governors of the Federal Reserve, the University of Wisconsin, the University of Pittsburgh, Washington University in St. Louis, Indiana University, Texas A&M University, the University of Cincinnati, University of Alabama, Arizona State University-West, California State University-Fullerton, and the 1999 Western Finance Association annual meeting.


Many empirical “anomalies” are actually consistent with the single beta capital asset pricing model if the empiricist utilizes an equity-only proxy for the true market portfolio. Equity betas estimated against this particular inefficient proxy will be understated, with the error increasing with the firm's leverage. Thus, firm-specific variables that correlate with leverage (such as book-to-market and size) will appear to explain returns after controlling for proxy beta simply because they capture the missing beta risk. Loadings on portfolios formed on relative leverage and relative distress completely subsume the powers of the Fama and French (1993) returns to small minus big market capitalization (SMB) portfolios and returns to high minus low book-to-market (HML) portfolios factors in explaining cross-sectional returns.