Evidence on the Characteristics of Cross Sectional Variation in Stock Returns




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    • Daniel is from the Kellogg School of Management at Northwestern University. Titman is from the Carroll School of Management at Boston College. We thank participants of seminars at Dartmouth, Harvard Business School, MIT, Northwestern, UCLA, University of Chicago, University of Illinois Urbana-Champaign, University of Michigan, University of Southern California, University of Tokyo, Wharton, the February 1995 NBER Behavioral Finance Workshop, the Pacific Capital Markets, Asia Pacific Finance Association and American Finance Association conferences, and Jonathan Berk, Mark Carhart, Randy Cohen, Douglas Diamond, Vijay Fafat, Wayne Ferson, Kenneth French, Narasimhan Jegadeesh, Steven Kaplan, Mark Kritzman, Josef Lakonishok, Craig MacKinlay, Alan Marcus, Chris Polk, Richard Roll, Robert Vishny, and especially Eugene Fama for helpful discussions, comments, and suggestions. We also wish to thank the editor, René Stulz, and an anonymous referee for their thoughtful suggestions. Daniel thanks the Center for Research in Security Prices (CRSP) at the University of Chicago for research support. Titman gratefully acknowledges research support from the John L. Collins, S.J. Chair in International Finance. We are, of course, responsible for any errors.


Firm sizes and book-to-market ratios are both highly correlated with the average returns of common stocks. Fama and French (1993) argue that the association between these characteristics and returns arise because the characteristics are proxies for nondiversifiable factor risk. In contrast, the evidence in this article indicates that the return premia on small capitalization and high book-to-market stocks does not arise because of the comovements of these stocks with pervasive factors. It is the characteristics rather than the covariance structure of returns that appear to explain the cross-sectional variation in stock returns.