An investigation into the cross-sectional determinants of expected stock returns in the London Stock Exchange

• Main Author: Leledakis, George
• Published: University of Warwick 2000
• Subjects: 332; HG Finance
• Online Access: https://ethos.bl.uk/OrderDetails.do?uin=uk.bl.ethos.341562

This thesis entails the examination of the determinants of the cross-section of stock returns in the London Stock Exchange, over the period July 1975 to June 1996, and it brings us a step further in the integrated real and financial view of the firm’s stock returns. The recent empirical evidence on the behaviour of stock returns in the U.S. and other equity markets around the world is reviewed in chapter 2. We broadly classify the findings as being cross-sectional (e.g., asset pricing anomalies) or time series (e.g., calendar effects, return autocorrelations and other forecasting variables) in nature. Chapter 3 describes our data set and presents the methods used to test the alternative hypothesis that the expected stock returns were not determined solely by their risk characteristics such as market beta, but other additional characteristics. In order that our results should have greater appeal, we use a broad data set on 1,420 stocks quoted on the London Stock Exchange. Thus, the use of such a broad data set provides a unique opportunity for the analysis of the behaviour of stock returns. The Tobin’s q ratio (the ratio of the market value of the Firm to the replacement costs of its assets) in explaining the cross-section of average stock returns introduced in chapter 4. Our motivation for using the Tobin’s q, for the first time in this literature, as an additional variable in explaining the cross-section of average stock returns is the lack of theoretical rationale of the predictive ability of the Firm-specific variables. Tobin’s q allows us to suggest that it may incorporate, to some degree, potential alternative sources of risk such as product price risk, poor investment opportunities risk and Financial distress risk. Our results confirm the Tobin’s q effect; stocks with a smaller Tobin’s q ratio yield a higher average returns. An investigation into the relationship between the average return and the most common used variables in the U.S. and Japanese markets (such as market value of equity, book to market equity, leverage, earnings to price, cash flow to price and dividend yield), as well as their relationship with each other is reported in chapter 5. Our results confirm that the empirical regularities observed in the U.S. market also exist in other countries (e.g., U.K. stock market). Thus we conclude that it is extremely unlikely for the book to market equity and the market value of equity effects, which are reported for the U.S. stock market, to be a consequence of data- snooping.