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The pricing of equity on the London Stock Exchange: seasonality and size premium

Author: Hawawini, Gabriel ; Corhay, Albert ; Michel, PierreINSEAD Area: Finance In: Stock market anomalies - Dimson, Elroy - 1988 - Book Language: EnglishDescription: p. 198-212.Type of document: INSEAD ChapterNote: Please ask us for this itemAbstract: In this study the relationship between average monthly returns and risk for portfolios of common stocks traded on the London Stock Exchange (LSE) is examined. The validity of the capital asset pricing model (Sharpe, 1964, Black, 1972) is tested using a methodology similar to that of Fama and MacBeth (1973). This is the first empirical test of the CAPM on the LSE that uses the Fama-MacBeth methodology. Using the LSE data two phenomena recently observed on the New York Stock Exchange (NYSE) are also investigated. The first is the size effect discovered by Banz (1981). He showed that small capitalization firms earn, on average, higher risk-adjusted returns than large capitalization firms. The second phenomenon was documented by Tinic and West (1984-1986). They showed that the estimated slope coefficient (risk premium) of the relationship between average returns and systematic risk on the NYSE is significantly positive only in January. During the rest of the year there is no significant relationship between average returns and systematic risk on the NYSE. In other words, the CAPM is valid only in January on the NYSE.
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In this study the relationship between average monthly returns and risk for portfolios of common stocks traded on the London Stock Exchange (LSE) is examined. The validity of the capital asset pricing model (Sharpe, 1964, Black, 1972) is tested using a methodology similar to that of Fama and MacBeth (1973). This is the first empirical test of the CAPM on the LSE that uses the Fama-MacBeth methodology. Using the LSE data two phenomena recently observed on the New York Stock Exchange (NYSE) are also investigated. The first is the size effect discovered by Banz (1981). He showed that small capitalization firms earn, on average, higher risk-adjusted returns than large capitalization firms.
The second phenomenon was documented by Tinic and West (1984-1986). They showed that the estimated slope coefficient (risk premium) of the relationship between average returns and systematic risk on the NYSE is significantly positive only in January. During the rest of the year there is no significant relationship between average returns and systematic risk on the NYSE. In other words, the CAPM is valid only in January on the NYSE.

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