Morningstar Advisor - October/November 2012 - (Page 49)

Great Papers in Factor Investing Market 1961– 1962 1964 “Market Value, Time, and Risk” and “Toward a Theory of Market Value of Risky Assets,” both by Jack L. Treynor, develop a model on capital asset pricing and capital budgeting. The former paper was never published, the latter not until 1999. “Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk,” by William Sharpe, finds that a stock’s expected return, and therefore its price, is based on its market risk, or “beta.” “The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets,” by John Lintner, separately develops a capital-asset-pricing model that is similar to Sharpe’s. “Equilibrium in a Capital Asset Market,” by Jan Mossin, is yet another separate, original CAPM. “The Capital Asset Pricing Model: Some Empirical Tests,” by Fischer Black, Michael C. Jensen, and Myron S. Scholes, finds that high-beta stocks underperformed relative to CAPM’s prediction. “Investment Performance of Common Stocks in Relation to Their Price-Earnings Ratios: A Test of the Efficient Markets Hypothesis,” by Sanjoy Basu, documents the value effect. “Book Values and Stock Returns,” by Dennis Stattman, documents outperformance by high book-to-market stocks. “The Relationship Between Return and Market Value of Common Stocks,” by Rolf Banz, documents historical outperformance of small-cap stocks versus large-cap stocks. “Asset Pricing and the Bid-Ask Spread,” by Yakov Amihud and Haim Mendelson, shows that stocks with wider bid-ask spreads have higher returns. “Dividend Yields and Expected Stock Returns,” by Eugene F. Fama and Kenneth French, overturns consensus that prices follow a random walk by showing that risk premiums are correlated with business cycles; during recessions people require higher premiums. “The Cross-Section of Expected Stock Returns,” by Eugene F. Fama and Kenneth R. French, is the beginnings of the FamaFrench three-factor model. This paper finds that size and book-to-market equity describe the cross-section of average stock returns. “Common Risk Factors in the Returns on Stocks and Bonds,” Eugene F. Fama and Kenneth R. French, identifies five risk factors that explain the average returns on stocks and bonds. For stocks, the factors are overall market (CAPM), firm size, and bookto-market equity: the Fama-French three-factor model. “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency,” by Narasimhan Jegadeesh and Sheridan Titman, documents abnormal returns to a monthly strategy of buying highest-return stocks over past 12 months and short-selling lowest-returning. 1965 1966 1972 Value 1977 1980 Size 1981 Liquidity 1986 Market 1988 Fama-French three-factor model 1992 1993 Momentum 1997 “On Persistence in Mutual Fund Performance,” by Mark M. Carhart, extends the Fama-French three-factor model to include momentum. “Liquidity Risk and Expected Stock Returns,” by Lubos Pastor and Robert F. Stambaugh, finds that illiquid stocks produced higher returns than did liquid stocks, adjusted for exposures to the market, size, value, and momentum. “Liquidity as an Investment Style,” by Roger G. Ibbotson, Zhiwu Chen, and Wendy Y. Hu, shows that a stock’s liquidity is just as strong as, but distinct from, traditional factors, such as size, value, and momentum. Liquidity 2003 2011 MorningstarAdvisor.com 49 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - October/November 2012

Morningstar Advisor - October/November 2012
Contents
Contributors
Letter From the Editor
Ill Communication
Do You Use Factor-Investing Strategies?
Practicing What She Preaches
How to Determine the True Price of ETFs
The Quant Factor
Managers Dispute the Death of Equities
Investments á la Carte
Investment Briefs
Five Inconvenient Truths of Manager Research
Health Care’s Outlook Clarifies
Exploring the World of Factors
Uncloaking the Alpha Machine
Factor Strategies Gain Footholds in Practices
Big Mo
Fitting Factors Into the Formula
Clients Have a Friend in Luther King
Less-Liquid Holdings Mean More-Solid Results
Retirement-Withdrawal Strategies Quantified
Amid Turmoil, Don’t Discount Foreign Equities
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Should I Stay or Should I Go?

Morningstar Advisor - October/November 2012