SYNOPSIS OF “SIZE, VALUE, AND

MOMENTUM IN INTERNATIONAL STOCK

RETURNS”

Introduction

There have been a lot of work which has been credited on pricing of an asset and some of the

work has been nobly accredited. These work includes the model proposed by William Sharpe

(1964), Eugene Fama & K.R. French (1993) and Carhart (1997). All the above authors have

produced their work based on earlier work on portfolio selection by Markowitz (1952). Many of

these earlier studies have proposed that growth stocks have lower average returns than stocks

with high book-to-price or cash-to-price ratio (Banz, 1981; DeBondt & W.F.M., 1985; Fama and

French, 1992; Carhart, 1997). It was also stated that U.S. security that have done comparably

well and have given a higher return over the past period tend to carry on the same for the next

period (Jegadeesh & Titman 1993). Carhart (1997) theory proposed that stock market also exibit

momentum. This was well evident in international markets (Fama and French, 1998; Chui,

Titman, and Wei(2010). This paper tries to test the value and momentum configurations in the

international market’s average return by empirical and pragmatic asset pricing models on four

regions which are North America, Europe, Japan and Asia Pacific. The paper examines the local

and global versions of the empirical models for each of these four regions.

Summary

The paper revolves around the theme of testing the empirical models in the four regions from the

period November 1990 to March 2011, and tests their robustness in the form of momentum

patterns in international average returns. The paper centrally have two main objectives. The first

is to pattern the developed market’s element on average returns in terms of size, value and

momentum by covering all size groups. The second aim is to assess the robustness of the

empirical models capturing mean returns for portfolios also fashioned on size, value as well as

momentum. To explain the regional returns and to assess that the empirical models integrated

across regions, the paper also examines the models for local and global factors. The pattern in the

average return is the main driver for the two models introduced Fama and French (1993) and

Carhart (1997). Carhart (1997) introduced a new factor in the model proposed by Fama and

French (1993) enriched with momentum return (WML(t)), which is the difference between the

monthly “t” returns on diversified portfolios of the winners and losers of the past year.

Gibbions, Ross and Shanken (GRS, 1989) F-Test, was conceded to check its robustness and

explain the excess returns on the selected portfolios. The main testing base for this study is that

whether the cross-section of the probable returns arrests the slopes and the expounding yields, so

that the true intercepts are zero for all the computed portfolios, based on size and momentum

(left-hand-side (LHS)) to the right-hand-side (RHS) portfolios, based on size and book-to-market

ratios. This objective is to observe whether in international markets the asset pricing models

arrest the value-momentum patterns and to which degree asset pricing assimilates between the

developed markets.

They found that the international value premiums of small stocks were larger than anticipated.

However, the study showed strong momentum earnings in all 23 countries in four regions except

Japan, where they found that momentum returns were higher for small stocks. Moreover, HML

(t) factors formulated from book-to-market ratios had higher rebuffs than factors specifically

formed on Cash Flow-to-Price (C/P). Although they found weaker factor portfolios for earning-

to-price (E/P) and C/P than book-to-market (B/M) portfolios but they observed that SMB and

HML explanatory returns saw size patterns in average value premiums for both E/P and C/P

portfolios. The authors also found that high book-to-market portfolios tend to have higher mean

returns than portfolios with big extreme value, which inferences that there exists a challenge for

asset pricing model to deal with common size patterns in value premiums. It infers that the

hybrid models does not provide explanation of returns and mean returns as compared to their

local counter parts and add no value, as the R2remains unchanged.

It was evident from the results that there exists a common pattern in the mean returns in the four

tested regions. Overall, in all the developed markets momentum returns were evident except

Japan. However, GRS test rejected the hypothesis for the paper that the true intercepts are zero

for all the three models. This states that the models do not capture the patterns integrated across

regions. However, the models if considered separately could explain some parts of the

complicated world’s market for e.g. to assess the returns on global portfolios, four-factor model

could be used. Conversely, rejection by the GRS model suggests that regional size-momentum

and size-B/M portfolios for the global models do not explain mean returns well. Nevertheless,

the local four-factor model manifested better results than three-factor model and CAPM.

Critique

Eugene F. Fama and Kenneth R. French have authored this article, “Size, value, and momentum

in international stock returns” focusing on four regions, being North America, Europe, Japan,

and Asia Pacific. Eugene F. Fama, a noble laureate is a professor at Booth School of Business,

University of Chicago, USA. Kenneth R. French is a Professor of Finance at the Tuck School of

Business at Dartmouth College, Hanover, USA. The authors are well recognized and qualified in

their field. They both together have produced ground breaking work in asset pricing in the field

of financial economics, which has been nobly accredited.

This article was etched to test the empirical asset pricing models on whether these models

capture the value momentum patterns and whether these models are integrated across the above

stated regions. The paper is easy to comprehend as topics are well defined with proper

explanation and tables wherever needed, making the paper more structured and easy to stream.

The arguments in the articles are clearly stated and tests the stated models thoroughly. The tested

models being the center of the financial world today makes this study more viable as it throws a

light on the robustness of the models. The authors have integrated previous studies in order to

support the importance of their research.

Although, the study provides analysis to sort out comprehensively the asset pricing models for

different regions in the developed market and states which model gags the best results but market

integration could be a problem for the models as Asia-Pacific developed market could have

different variables in play to the developed markets in European region. However, the paper

provides a new base for the future development in the field of asset pricing. The paper is of

significance as it creates a room for practitioners to entrench new horizons in asset pricing. The

results suggest that the value or momentum strategies could be devised in order to reduce the

portfolio’s volatility which provides an insight for the global investor and their roles in the global

economy. However, the paper is just provides a critique of the asset pricing models available in

the field of financial economics.

The author, in this paper, integrates the data from Bloomberg, enhanced by DataStream and

Worldscope. The sample is from November 1989 till March 2011. Moreover, to assess the

momentum patterns, the data period was again striped of to 1991 till 2010. The study might have

suffered from short sample size than the earlier studies e.g. Fama and French (1993) considered

data for more than 25 years. This inconsistency could have led to distorted results. Furthermore,

the division of portfolios to left-hand-side (LHS) and the right-hand-side (RHS) portfolios in the

four regions could have masked the inconsistency of the asset pricing models as a whole. The

restriction on LHS portfolios which are based on B/M or size and momentum may have less

success to price the assets accurately than if formed in a different ways. There may exist many

anomalies, which could have tilted the data and caused variations in the results. This major flaw

could have been a decisive factor in either accepting or rejecting the models. Besides, it could tilt

the models in extreme momentums and the application of the models could give misleading

results (Carhart (1997), Fama and French (2010).

The models used by the authors have ranged portfolio stocks from smallest to the most expensive

ones e.g. mutual funds. Some of the considered portfolios cannot be shorted due to the

regulations of their respective country’s policy. The paper fails to identify the use of shorting or

the importance for the same in relation to the profitability of the portfolio formation strategy.

Moreover, if we consider a small stock, then it becomes difficult and expensive to trade.

Therefore, sensitivity to liquidity of the assets could be a problem in redeeming returns. This

could lead to disappearance of expected premium or would significantly impact on the premium

size.

The paper executes many regressions and presents its data without explaining the inferences of

the results produced. This seems to be seminal research paper. The findings of the paper are

simply stated which leaves a room for other practitioner to interpret them and use the findings for

which it could be to formularize a better theory in asset pricing. However, these regressions

could also be alleged as merely screening patterns in the data, without a proper explanation, or

could be the coincidences of randomness. Moreover, without a proper theory to support the data,

it could not have a practical insinuations. In addition, the paper fails to explain the degree of the

momentum effect in the different markets and generally rejects or accepts the models, i.e. the

paper struggles to explain the momentum market anomaly, making the paper’s finding a

cognitive bias.

Moreover, GRS (Gibbons, Ross & Shanken 1989) test was applied on all the models to test their

robustness. The model assumes that the monthly stock returns are normally distributed.

However, there have been a lot of shifts in the market returns moving in extreme directions.

Consequently, true distribution of market could be leptokurtic and could lead to skewed results

and faulty inferences, since, the F-test of GRS tends to over-reject the null hypothesis. Moreover,

a newer version of Fama and Macbeth (1973) test should have also been conceded, which is the

Net Beta Test by Guermat and Freeman (2010), which has lower standard error, to support their

results. Although, the GRS test is one of the major stable efficiency test currently available and

has a higher power, but to test these asset pricing model’s mean-variance efficiency, more

detailed analysis should have been prompted to infer unwavering results.

Conclusion

The main objective of the paper was to test the empirical asset pricing models and to assert

whether these models capture any patterns in momentum and value in the global market’s mean

return and also whether these models are cohesive transversely in the international market over

the period of 20 years. The paper tries to test the data with local and global variables with both

local and global pricing models. They found a positive and sizable value premiums in all the

international market in four tested regions. It was evident in there study that all the regions had

sizable momentum premium except Japan where small capitalization companies had strong

momentum premiums as compared to large capitalization companies. They concluded that in

some regions the momentum factor produced better fit.

Although, the paper has good inferences, however, it fails to clarify why the degree of small-ness

and value-ness of a stock should influence the stock’s return. Additionally, the division of

portfolios into value and size categories based on regional returns seems rather subjective and

not based on any fundamental economic models which governs asset pricing. Though, the results

did not find high significance level, they were able to capture the cross-section of estimated

returns since, however, regression intercepts remained close to zero for all the countries in the

study. Moreover, they did not find a good fit in there models once they regressed the global

market variables of size and value to the regional factors and concluded that the local markets are

not globally cohesive.