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UK Evidence on the Characteristics versus Covariance Debate

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  • Edward Lee
  • Weimin Liu
  • Norman Strong

Abstract

We evaluate the Fama–French three‐factor model in the UK using the approach of Daniel and Titman (1997) to determine whether characteristics or covariance risk better explains the size and value premiums. Across all three factors, we find that return premiums bear little relationship to the corresponding loadings. We show that small and value stocks earn higher returns irrespective of their return covariance. Our study contributes to the existing literature by reporting original findings on the Fama–French three‐factor model in the UK and by reporting results that complement existing evidence from similar studies in the USA and Japan.

Suggested Citation

  • Edward Lee & Weimin Liu & Norman Strong, 2007. "UK Evidence on the Characteristics versus Covariance Debate," European Financial Management, European Financial Management Association, vol. 13(4), pages 742-756, September.
    • Handle: RePEc:bla:eufman:v:13:y:2007:i:4:p:742-756
    DOI: 10.1111/j.1468-036X.2007.00381.x
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    References listed on IDEAS

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    Cited by:

    1. Ebrahim, M. Shahid & Girma, Sourafel & Shah, M. Eskandar & Williams, Jonathan, 2014. "Rationalizing the value premium in emerging markets," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 29(C), pages 51-70.
    2. Nguyet T. M. Nguyen & Abdullah Iqbal & Radha K. Shiwakoti, 2022. "The context of earnings management and its ability to predict future stock returns," Review of Quantitative Finance and Accounting, Springer, vol. 59(1), pages 123-169, July.
    3. Isaac T. Tabner, 2012. "In Defence of Capitalisation Weights: Evidence from the FTSE 100 and S&P 500 Indices," European Financial Management, European Financial Management Association, vol. 18(1), pages 142-161, January.
    4. M. Eskandar Shah & Sourafel Girm & R. Hudson, 2012. "Rationalizing the Value Premium under Economic Fundamentals in an Emerging Market," Working Papers 12010, Bangor Business School, Prifysgol Bangor University (Cymru / Wales).
    5. Kariofyllas, Spyridon & Philippas, Dionisis & Siriopoulos, Costas, 2017. "Cognitive biases in investors' behaviour under stress: Evidence from the London Stock Exchange," International Review of Financial Analysis, Elsevier, vol. 54(C), pages 54-62.

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