I thank Philip Gray and an anonymous referee for helpful comments.
Risk-based explanation for the book-to-market effect
Article first published online: 22 AUG 2011
© 2011 The Author. Accounting and Finance © 2011 AFAANZ
Accounting & Finance
Volume 52, Issue Supplement s1, pages 137–154, October 2012
How to Cite
Chen, J. W. (2012), Risk-based explanation for the book-to-market effect. Accounting & Finance, 52: 137–154. doi: 10.1111/j.1467-629X.2011.00442.x
- Issue published online: 5 OCT 2012
- Article first published online: 22 AUG 2011
- Received 6 August 2009; accepted 1 August 2011 by Philip Gray (Editor ).
- Asset pricing;
- Book-to-market effect;
- Efficient markets hypothesis
This paper proposes a risk-based explanation for the book-to-market (B/M) effect. I decompose B/M into net operating asset-to-market (NOA/M) and net financing asset-to-market (NFA/M) components. Portfolio analysis shows that (i) positive B/M, NOA/M and NFA/M are positively related to future returns and (ii) negative B/M, NOA/M and NFA/M are negatively related to future returns. To the extent that positive B/M, NOA/M and NFA/M act as measures of asset risk and negative B/M, NOA/M and NFA/M act as inverse measures of borrowing risk, the nonlinear relations between B/M, NOA/M and NFA/M and future returns provide some evidence to support the risk-based explanation for the book-to-market effect in stock returns.