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Semiparametric modelling of the cross-section of expected returns in the German stock market

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  • Stehle, Richard
  • Bunke, Olaf
  • Sommerfeld, Volker

Abstract

According to the Sharpe-Lintner capital asset pricing model, expected rates of return on individual stocks differ only because of their different levels of non-diversifiable risk (beta). However, Fama/French (1992) show that the two variables size and book-to-market ratio capture the cross-sectional variation of US stock returns better than other combinations of two variables. They report also that in the 1963-1990 period beta has virtually no explanatory power. This paper looks at a comparable data set for Germany for the time period 1968-1990. We analyze this data set in order to identify a best nonlinear model for the relationship between rates of return, beta, size and book-to-market. The model and corresponding regression estimates are chosen by cross-validation among a very rich class of parametric, semiparametric and nonparametric alternatives. The coefficients in the model are estimated each year. The major result is that the parametric model proposed by Fama/French for US stock returns is almost the best one in Germany. The book-to-market-ratio turns out to be the variable with highest partial correlation with the stock return. In most of the annual regressions the corresponding coefficients have the correct sign and are statistically significant.

Suggested Citation

  • Stehle, Richard & Bunke, Olaf & Sommerfeld, Volker, 1997. "Semiparametric modelling of the cross-section of expected returns in the German stock market," SFB 373 Discussion Papers 1997,95, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
    • Handle: RePEc:zbw:sfb373:199795
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    References listed on IDEAS

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    1. Bunke, O. & Droge, B. & Polzehl, J., 1995. "Model Selection, Transformations and Variance Estimation in Nonlinear Regression," SFB 373 Discussion Papers 1995,52, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
    2. Hardle, Wolfgang & Linton, Oliver, 1986. "Applied nonparametric methods," Handbook of Econometrics, in: R. F. Engle & D. McFadden (ed.), Handbook of Econometrics, edition 1, volume 4, chapter 38, pages 2295-2339, Elsevier.
    3. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    4. Fama, Eugene F & French, Kenneth R, 1992. "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    5. Fama, Eugene F & French, Kenneth R, 1995. "Size and Book-to-Market Factors in Earnings and Returns," Journal of Finance, American Finance Association, vol. 50(1), pages 131-155, March.
    6. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
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    Cited by:

    1. Schulz, Rainer & Werwatz, Axel, 2001. "A state space model for Berlin house prices," SFB 373 Discussion Papers 2001,58, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.

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