Assessing Sorting Portfolios

Jürgen Ernstberger
Ruhr-University Bochum, Chair for Accounting and Auditing
Universitaetsstrasse 150, D-44801 Bochum - Germany

Harry Haupt
Bielefeld University, Centre for Statistics
PO Box 100131, 33501 Bielefeld, Germany

Oliver Vogler
Ruhr-University Bochum, Chair for Accounting and Auditing
Universitaetsstrasse 150, D-44801 Bochum - Germany
+49-175-3189182, mail@olivervogler.de

Preprint submitted to AJEBA 25 October 2009

Electronic copy available at: http://ssrn.com/abstract=1108361

Abstract

Problem statement: This paper investigates the role of sorting portfolios in eval-
uating asset pricing models. With the rising number of empirical studies about asset
pricing models, the comparability of these effects suffers from (1) different aggrega-
tional levels of firm returns, (2) different models, i.e. Capital Asset Pricing Model
(CAPM) vs. the Fama and French model, and (3) time varying factor risk loadings
causing uncertainty. Our objective is to address these issues by providing valuable
insights into how sorting portfolios influence the performance of asset pricing models
and compare these effects in an up-to-date study.
Approach: We consider four distinct types of aggregation levels of returns, i.e.
industry-level as well as beta-sort, beta-size-sort, and size-book-to-market-sort port-
folios. By using a recent twenty year sample of U.S. stock market data (and sub-
samples thereof), the CAPM and several multi-factor models are investigated using
different regression methods and tests.
Results: We provide evidence that sorting portfolios can highly improve the
performance of the models. In particular, we find that beta-sorting improves the
performance of the CAPM, while portfolios built according to size and book-to-
market enhance the Fama and French model. For all analyzed types of portfolios
the three-factor model turns out to be superior to the CAPM both statistically and
economically. Applying state-of-the-art median regression analysis, we also find that
the role of the unspecified part (alpha) of the CAPM changes when looking at the
tails of the return distribution.
Conclusion: We conclude that the success of the three-factor model is not re-
stricted to its factor-mimicking portfolios. Our findings support claims toward using
multi-factor models instead of the classic CAPM. This holds not only on average
but for large parts of the conditional return distribution, meaning that there is a
strong empirical evidence in favor of the location-shift hypothesis.

Keywords: sorting portfolios, asset pricing, Fama-French model, CAPM

JEL Classification: G12, G31

Electronic copy available at: http://ssrn.com/abstract=1108361

1 Introduction

With the rising number of empirical studies exploring asset pricing models, different
ways of portfolio-building have emerged. While the first empirical Capital Asset
Pricing Model (CAPM) studies had started to use beta-sorted portfolios in order to
improve statistical inference, later on anomalies were often associated with different
kinds of sorting procedures and factor-mimicking portfolios, like size or book-to-
market portfolios. In this paper we empirically demonstrate that different sorting
strategies influence the success of both the CAPM and multifactor models, especially
the three-factor asset pricing model by Fama and French 15 .
In general, evaluating asset pricing models raises several issues. First of all, the
aggregational level of returns has to be determined. While it is common today to
sort portfolios according to different firm characteristics, also “naive” classifications
into industries exist e.g. 19 . Second, it is not clear which model to apply. Despite
still playing a dominant role among practitioners, the consensus today is that the
CAPM fails to adequately explain the cross-section of asset returns, since over time
more and more anomalies have been found that cannot be explained by the CAPM.
As a consequence Fama and French 14, 15 developed their influential three-factor
asset pricing model. Finally, in applications two additional empirical problems occur:
Time varying factor risk loadings cause uncertainty in the estimated loadings and
estimates of factor risk premiums are also regarded to be time period-specific e.g. 19 .
The motivation of this paper is to address these issues by providing valuable insights
into how sorting portfolios influence the performance of asset pricing models.

1.1 Asset Pricing Theory

The Capital Asset Pricing Model (CAPM) can be expressed through the familiar
Sharpe -Lintner equation:

E[Ri ] = Rf + βi (E[RM ] − Rf ) i = 1, . . . , N. (1)

The expected return on asset i is the risk-free interest rate, Rf , plus a risk premium,
which is the asset’s market beta, βi , times the premium per unit of beta risk, E[RM ]−
Rf . The basic idea of the CAPM is that each asset’s expected excess return, i.e. the
part of E[Ri ] that exceeds Rf (or simply E[Ri ] − Rf ), should increase in proportion
to its beta. Beta, βi , can be seen as the contribution of asset i to the market risk
and represents the “systematic” risk of asset i.
Regarding the intercept, the CAPM predicts equality to the risk-free rate, Rf .
This characteristic was used to propose a time-series version of the CAPM, adding
“Jensen 28 ’s alpha” as intercept, with the economic implication that the intercept
should be zero:
E[Rit ] − Rf t = αi + βi (E[RM t ] − Rf t ). (2)
In practice, however, studies consistently find significantly positive intercepts α̂i ,

3
which are interpreted as pricing errors e.g. 8,23,14 . Furthermore over time strong em-
pirical evidence was presented that other variables than the market excess return
capture variation in expected return missed by the CAPM beta, e.g. firm size 2 ,
earnings-to-price ratio, E/P 5 , the leverage effect of the debt-to-equity ratio, i.e.
book value of debt to market value of equity 7 , and the book-to-market ratio, i.e.
book value of common equity to the market value of equity, BE/ME 41,39 .
Fama and French 14 synthesize these prior findings and confirmed that factors based
on ME, E/P, debt-to-equity, and BE/ME add explanatory power to the CAPM.
Fama and French 15 finally present two innovative factors that can sufficiently ex-
plain the additional variation in expected returns. In their three-factor model, stocks
of small firms and those with a high BE/ME had not only provided significant above-
average returns in the past. But also, by adding a value factor and a size factor to
the overall market beta, Fama and French could highly improve the explanatory
power of the CAPM. This leads to the following equation:

E[Rit ] = Rf t + βiM (E[RM t ] − Rf t ) + βis E[SMB t ] + βih E[HMLt ]. (3)

Based on factor-mimicking portfolios, SMB represents the difference between the

returns of small and large capitalization firms (in terms of ME), while HML stands
for the difference between the returns of high and low BE/ME firms. Hence, the
coefficients βis and βih reveal the exposure to these factors in the same way as
βiM does for the market risk. The explanations for the success of these factors are
different. On the one hand, differences in size (ME) arbitrarily affect stock prices. For
prices have information about returns, size is a proper candidate to add explanatory
power to the CAPM 20 . On the other hand, stocks with high BE/ME are “value
firms”, whereas low BE/ME are associated with “growth firms”. Sorting firms on
the BE/ME exposes investors’ overreaction to good and bad times. Because investors
usually overreact toward past performance, the resulting stock prices are too high
for growth firms and too low for distressed value firms 16 .
Beyond the two Fama and French factors, Jegadeesh and Titman 27 find that well
performing stocks continue to perform well, and stocks that do poorly continue to
do poorly. Carhart 10 was the first to include a momentum factor, i.e. the difference
between the returns on diversified portfolios of short-term winners and loser. Fama
and French 17 acknowledge that their three-factor model fails to account for the
cross-sectional differences in momentum-sorted stock portfolios. A recent study by
Ray et al. 38 , however, comes to the conclusion that the Carhart four-factor model
is not superior to the Fama and French three-factor model. Taken together, there
is a growing number of studies that proclaim more powerful models compared to
the CAPM. Not only ME, but also e.g. E/P or BE/ME add significantly to the
explanation of average returns (see Fama and French 18 , p. 1956, for a list of relevant
studies). Lately, also accounting related factors like e.g. persistence, smoothness and
predictability 24 , or accruals quality 25 have been included. Overall, as Fama and
French 18 , p. 1957 conclude, “the average-return anomalies of the CAPM are serious
enough to infer that the model is not a useful approximation.”

4
1.2 Sorting Portfolios

Today, stock returns are routinely sorted according to different characteristics before
their returns are analyzed. The most common way to form these portfolios is to split
the sample and use pre-rankings of the first period in order to construct portfolios
in the second period. The actual portfolio performance is evaluated for both the
ranking period and the subsequent test period 1 .
Initially, sorting was conducted with a single sorting variable such as the pre-ranking
beta to generate more precise portfolio beta estimates 8 . In that context Fama and
MacBeth 23 also highlight the necessity of splitting the sample in two periods. Using
only the full-sample to do both pre-ranking and estimating leads to the observation
that high estimates of betas tend to be above the true parameters and low estimates
tend to be below the true parameters. To avoid this effect portfolios are formed
upon pre-estimated ranked betas. Subsequently, other firm-specific characteristics
were adopted to discover empirical anomalies. Banz 2 introduces the idea of sort-
ing portfolios according to size (ME) and grouped equity returns on two variables,
namely size and pre-ranking beta. In their influential paper, Fama and French 14
evaluate returns based on different portfolios (beta, ME, BE/ME, E/P, beta vs.
ME, and ME vs. BE/ME), which was essential for finding the new factors in their
three-factor model 15 , where they cluster according to ME vs. BE/ME. Lakonishok
et al. 32 examine decile-portfolios formed on BE/ME, E/P, cashflow-to-price, and a
five-year sales rank. Additionally, they combine five-year sales ranks with the latter
variables, arguing that sorting on two variables produces larger spreads in average
returns. However, Fama and French 17 have little trouble to describe the latter port-
folios with their three-factor model. Only recently, Fama and French 22 extended the
double-sorting to size on the one hand and different other firm characteristics on the
other hand, like momentum, net stock issues, accruals, asset growth, and profitabil-
ity. 2 Furthermore, Daniel and Titman 13 sort equity returns on three variables: ME,
BE/ME, and the pre-estimation of risk factor loadings on either the market return,
SMB, or HML portfolios. This triple-sorting establishes their “characteristics-based”
asset-pricing model. Their results show that a firm’s average return is determined
directly by its characteristics and is independent of that firm’s factor sensitivities.
Chiao et al. 11 form portfolios on ME, BE/ME, and prior-returns, ultimately formu-
lating a new four-factor model based on factor-mimicking portfolios.
Despite the commonly acknowledged fact that sorting unavoidably leads to a loss in
information, only recently researchers have begun to formally analyze the theoretical
basis for the sorting procedure. The central problem is that the selection of firms

1 The advantage is that the β̂p of portfolios can be much more precise estimates of the
true βp than the β̂i of individual assets can be for the true βi see 23 614-8 for more details.
2 Note that Fama and French 22, 21 , when sorting on size, built an extra portfolio for “tiny”

or “micro” stocks, which they did not before. When Kothari et al. 31 had confronted the
Fama and French 15 model with a “survivor-bias” effect, Fama and French 18 had been
able to defend their model largely, but not for tiny stocks.

5
to be included in a portfolio is almost never random, but is often based on some
of the firm’s empirical characteristics see also 6,33,26,1 . Lo and MacKinlay 35 argue
that ex-ante knowledge about the correlation between the sorting variable and the
returns leads to a data-snooping bias. Their argument is that grouping firms on some
characteristics that is mainly empirically motivated may violate the significance
tests. This is especially the case for the size effect in literature. Still, Campbell,
Lo and MacKinlay 9 later on admit that it is practically hard to adjust for the
data-snooping bias.
Nevertheless, sorting portfolios can actually be seen to be one of the most important
means to evaluate the performance of asset pricing theory. Even though previous
literature has questioned the methodological applicability of sorting techniques, a
study consistently exploring the performance of different sorting approaches is still
missing. This is surprising, since many studies apply a sorting procedure when test-
ing multifactor models. We try to address this issue by explicitly evaluating the
impact of different sorting procedures. Moreover, we compare the CAPM and the
Fama and French three-factor model for different types of portfolios.

2 Materials and Methods

We estimate the time-series version of the CAPM from equation (2) above and the
Fama and French model which captures size and book-to-market effects as separate
factors, but we also add an additional intercept α:

Rit − Rf t = αi + βiM (RM t − Rf t ) + βis SMB t + βih HMLt + εit , (4)

where SMB is the difference between the return on a portfolio of small firms and the
return on a portfolio of large firms (“small minus big”) and HML is the difference
between the return on a portfolio of high book-to-market firms and the return on a
portfolio of low book-to-market firms (“high minus low”). 3
The advantage is that this procedure offers a clear interpretation for the size and
book-to-market effect as risk-factor sensitivities in the model. Moreover, by looking
at the intercept α in the regression, one can determine how exact the model can de-
scribe the excess returns by checking if the intercept is statistically and economically
not distinguishable from zero.
Since empirical research has shown that the market premium can vary considerably
over time e.g. 36 , in this paper we distinguish between the full sample and a split
into four sub-samples of 60 months each (resp. 47 months for the last sub-sample)
to compare time-specific effects of the market excess return 4 .

3 How these factors are computed is detailed in Section 2.2 of this chapter.
4 In empirical studies, the most commonly used time interval is 60 months see 9 .

6
2.1 Research Data

The data for this study stem from the COMPUSTAT North America database.
Basically, we use data for twenty years, i.e. the period from June 1987 to May
2007 (240 months), for all firms with SIC codes (9911 firms). Subsequently, different
criteria are set for the firms to remain in the sample.
First of all, all non-U.S. firms are left out for this study in order to ensure that the
macroeconomic and institutional background is comparable. Next, all financial firms
(SIC 6000-6999) are excluded since their book values are incomparable to the other
companies. 5 Moreover, firms with negative book value of equity are also taken out
due to the fact that negative BE values cannot be interpreted in economic terms.
To avoid data blurring all firms with non-valid data and returns that are greater
than 99 are excluded. All firms must have at least 24 months of data. This results
in a final number of 2766 firms for this study. The details of the sample selection
are summarized in table 1.
Place Table 1 about here
For the sample firms the following data are collected (with COMPUSTAT ID):
• Monthly Returns (R): The returns are derived as discrete returns using the average
monthly close prices of the firm stocks (PRCCM).
• Market value of equity (ME): ME is the average monthly close price (PRCCM)
times the number of common shares outstanding (CSHO).
• Book value of equity (BE): BE is the book value of stockholders’ equity (SEQ),
plus balance sheet deferred taxes (TXDB), plus post-retirement benefit obliga-
tions (PRBO), minus book value of preferred stock (PSTK) (see e.g. Fama and
French 19 , p. 155).
For the market excess return (E[RM t ] − Rf t ) the return on the market portfolio is
used as the value-weighted return of all firms included in the sample. The risk-free
rate is the three-month treasury bill rate (T-Bill-3 Month).

2.2 Factor Construction

For the computation of the SMB t and HMLt factors the specification of Fama and
French 19 , p. 155, is applied. SMB t and HMLt are based on factor-mimicking portfo-
lios. Firms are assigned into these portfolios every year and remain in one portfolio
for twelve months, namely from July to June.
In calender year t, the firms are grouped along two dimensions. On the first dimen-
sion (ME), firms are grouped into small (S) and big (B) based on whether their
5 Financial firms are routinely excluded in empirical studies, with only a few exceptions.
E.g., Fama and French 19 include financial firms for their industry comparison. Barber and
Lyon 3 explicitly compare financial and nonfinancial firms, assessing that “the relation
between firm size, book-to-market ratios, and security returns is similar for financial and
nonfinancial firms” (p. 875).

7
ME in June of year t is below or above the median of the data set. On the second
dimension (BE/ME), firms are sorted into three BE/ME portfolios. We assign the
lowest 30% into the low portfolio (L), the highest 30% into the high portfolio (H),
and the remaining 40% in the middle portfolio (M). The BE/ME ratio for year t is
computed according to the BE value of the fiscal year ending in calender year t − 1
and the ME value in December of t − 1.
The overlap of the two ME and three BE/ME portfolios delivers six size-BE/ME
portfolios (SL, SM, SH, BL, BM, BH). For these portfolios, the value-weighted
monthly returns are calculated from July of year t to June of year t + 1. SMB t
is the monthly difference between the average of the three small-firm portfolios (SL,
SM, SH) and the average of the returns on the three big-firm portfolios (BL, BM,
BH). HMLt is the monthly difference between the average of the two high-BE/ME
portfolios (SH, BH) and the average of the returns on the two low-BE/ME portfolios
(BL, SL). In the following year t + 1 the firms are re-aligned into the six portfolios. 6
In addition to that, these Fama and French factors are “trimmed” by excluding
the top 0.5% and the bottom 0.5% of returns whenever sorting the firms in order
to assign them into either the size or BE/ME portfolios. 7 In the following, these
trimmed data are used as “default” version of the SMB t and HMLt factors. For a
sensitivity analysis, the non-trimmed factors are also included, labeled by TSMB t
and THMLt (T stands for the total sample). Since for this portfolio assignment pre-
data are “used up” before the actual factors can be computed, in the following the
maximal time horizon is narrowed to the period from July 1988 to May 2007 (227
months). 8

2.3 Portfolio Construction

The focus of the following analysis is on four different ways of aggregation. Figure
1 provides an overview of the portfolio construction process.
IND49: Firms are arranged according to the industry they belong to, using the
Standard Industrial Classification (SIC) Code and the Fama and French pooling

6 Note that the split into six portfolios is arbitrary. Fama and French 15 , p. 9, hope that
the resulting tests “are not sensitive to these choices” and “see no reason to argue that
they are.”
7 Trimming and winsorizing the data set is a common practice to tackle outlier issues,

especially in the accounting practice see e.g. 25 . Usually, the 0.5 and 99.5 percentiles or
the 1 and 99-percentiles are either removed (trimming) or recoded (winsorizing). The
justification for these sample corrections is to avoid measurement errors.
8 As will be explained below, the data set used for estimation will only consist of only

167 months of data. In a recent paper, however, Ray et al. 38 stress the point that the
use of long time periods is prone to parameter instability due to structural breaks. Using
recursive residual methods and checks of stability of correlations between regressors over
time we do not find evidence for instability for the 167 months of data used here. Further
details are of course available on request.

8
 into 49 different industries 9 .
BETA10: We use the 10 beta-sort portfolios, proposed by Black et al. 8 . This is in
accordance to the Fama and MacBeth 23 paper, who chose nothing but 20 instead
of 10 beta-sort portfolios.
BESI25: We incorporate the improvement of Banz 2 by grouping according to two
different characteristics, adding size (ME) as the second dimension, is incorporated
SIBM25: The typical 25 ME and BE/ME portfolios as introduced by Fama and
French 15 are built.
Place Graph 1 about here
The firms are initially grouped into industry portfolios (IND49), according to the
Fama and French 49 industries, where they assign each NYSE, AMEX, and NAS-
DAQ stock to an industry portfolio based on its four-digit Standard Industrial Clas-
sification (SIC) code (COMPUSTAT). Since for this study the financial industries
(SIC 6000-6999) are left out, we have a total number of 45 industries.
The next aggregational level are the 10 beta-sort portfolios (BETA10), introduced
by Black et al. 8 . Since the true betas, βi , are unobservable and the estimated β̂i
cannot be used for the assignment due to the selection bias problem discussed above,
the sorting has to be executed based on a kind of instrumental variable. One obvious
type of instruments are pre-estimated betas (β̂i0 ) that are regarded as being highly
correlated but also an independent estimate of the actual beta. This generally allows
inference with only a small loss of efficiency 37 . Therefore, five years of previous data
are taken to obtain instruments β̂i0 . These are ranked to assign the firms into 10
beta-sort portfolios according to the deciles of that sort. Firms are only included if
they provide at least 24 months of data within the pre-estimation five-year period.
By repeating this procedure every year, “rolling” betas are derived for the portfolio
assignment. Consistent to the Fama and French periods above, this is done for the
July-to-June year. As this method consumes five years of pre-estimation data, the
remaining sample consists of 167 months of data (July 1993 to May 2007). By re-
aligning each year, 14 years of beta-sort portfolios are calculated. This is summarized
in table 2. This method relies on the crucial assumption that the true beta, βi , is
stationary in order to make the pre-estimation betas valid for the grouping.
Place Table 2 about here
Next we construct the 25 beta-size portfolios (BESI25). This two-dimensional sorting
is proposed by Banz 2 in order to analyze the size effect on returns. On the beta
dimension, again “rolling” betas are used to design the portfolios. Here, one can
tie on the previous beta-sort procedure to guarantee comparability between the
portfolios. Also, this is in fact quite similar to the way Banz constructs his portfolios.
To narrow the number of portfolios, every two adjacent deciles are combined, which
leads to five quintile-beta portfolios. On the size dimension, a ME sorting is carried
out, also discriminating between the quintiles. The ME value in June of year t is

9 For details see Fama and French 19 or Kenneth R. French’s website at

http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/.

9
taken to assign the firm into the portfolio year from July of year t to June of year
t + 1. Finally, the overlaps of these two dimensions define the 25 portfolios.
The last type of portfolios to look at are the 25 size-BE/ME portfolios (SIBM25).
This idea was first successfully incorporated by Fama and French 14 , even though
they built 100 portfolios instead of 25. To compare the differences between the beta-
size and size-BE/ME portfolios, the analysis is restricted to 25 groups though. Hence,
the size dimension is borrowed from above. For the BE/ME dimension, the BE/ME
values in December of year t − 1 are assigned to the 12 month period from July of
year t to June of year t + 1. Again, quintiles are determined and the intersections of
both dimensions determine the 25 double-sort portfolios.

2.4 Explanatory Variables

Table 3 summarizes the descriptive statistics of the explaining variables, including

the cross-correlations and a split into four different time periods: sub-period I from
July 1988 to June 1993 (60 months), sub-period II from July 1993 to June 1998 (60
months), sub-period III from July 1998 to June 2003 (60 months), and sub-period
IV from July 2003 to May 2007 (47 months). Choosing 60 months is consistent to
the beta-sort portfolio methodology followed.
Place Table 3 about here
The first interesting finding is that HMLt and THMLt seem not to be significantly
different from zero for the full sample, indicated by the t-statistics (absolute value
smaller than 1). Of course, the t-statistic is only valid for interpretation if the true
series are asymptotically normally distributed. When applying the Jarque-Bera test
(not reported), the normality hypothesis cannot be rejected for the HMLt (p-value
of 0.5500) and THMLt (p-value of 0.5229) series at the conventual significance levels.
Neither can it be rejected for RM (p-value of 0.3307). The p-value of Rf (0.0436) is
arguable. For SMB t and TSMB t , however, the null can be clearly rejected (p-values
smaller than 0.01), meaning these series do not show normality characteristics. In
general, as Fama and MacBeth 23 also note, stock returns are regarded as being “fat-
tailed”. Therefore in testing, when critical values are derived from the t-distribution,
these are smaller than the actual critical values, meaning that the significance levels
are likely to be overestimated and cause a bias toward rejection of the hypothesis
under consideration. Consequently, if a hypothesis cannot be rejected based upon
the calculated t-value and the critical value from the t-distribution this is on even
firmer ground, given that the distribution has actually fatter tails. This fosters the
conclusion that HMLt and THMLt are not significantly different from zero over
time. However, whether they are unhelpful for the regression analysis has to be
further investigated. In general, the economic significance could be much higher
than the actual statistical significance. Furthermore, the cross-correlations (over the
whole sample period) between SMB t and HMLt (as well as TSMB t and THMLt
respectively) are moderate and close to 0.40. In their seminal paper of 1993 , Fama
and French already report a correlation of -0.26 for these factors, concluding that

10
one should not “exaggerate the links between size and book-to-market equity”. Both
are “needed to explain the cross-section of average returns” (p. 447). Regarding the
different time periods, one can suspect that the variables are not fully stable over
time. For example, the market return average continually rises from 0.0129 in the
sub-period I to 0.0480 in sub-period IV. Therefore, a test upon the stationarity of
the variables is conducted. We apply the Augmented Dickey Fuller (ADF) test for
non-stationarity. The null hypothesis that the RM series has a unit root is clearly
rejected (p < 0.0001) for different specifications of the ADF test equation. The
same holds true for SMB t , TSMB t , HMLt , and THMLt (all p-values smaller than
0.0001). Noticeably, the test for the Rf series delivers a p-value of 0.2432 and we
cannot reject the null at any reasonable significance level. Yet in economic terms,
this is not surprising, since interest levels have clear trends over time and are not
mean-reverting.

2.5 Portfolio Returns

Regarding the industry classification (IND49), the number of firms per industry
segment varies. The minimum number of firms to be included into the segments
is 2 (IND5, Tobacco Products), the maximum number is 204 (IND37, Electronic
Equipment). On average there are 61.5 firms in each industry segment. Then, the
ME-weighted average returns per industry are computed. In table 4 the t-statistics,
the full-sample betas, and the size in percent of all industries are reported.
Place Table 4 about here
For the 10 beta portfolios (BETA10) the β̂p are calculated by employing the ME-
weighted returns of the full-period (i.e. 167 months) data. The descriptive statistics
are shown in table 5 (Panel A). It is interesting to mention that the portfolios with
betas around one are bigger than portfolios at the extremes of the beta-sort groups.
Place Table 5 about here
In order to check the stationarity of the betas over time, again unit root tests
(ADF) are performed for the ten averages of “rolling” betas, using the 14 yearly
beta estimates for each portfolio. Unfortunately, for 9 out of 10 β̂p0 we cannot reject
the null with p-values above 0.4, the remaining one has a p-value of 0.041. 8 , who
suggest this methodology, do not look at the portfolio averages of the pre-estimated
“rolling” betas themselves. They rather split the total sample into four sub-periods,
estimate the full-period betas, and note that these β̂p , with two exceptions, look
“fairly stationary” (p. 15). However, finding non-stationary betas is in line with
the Fama and French 19 results, documenting substantial temporal variation in the
CAPM betas of industries. Thus, using one full-period beta in the regressions later
on might actually be incorrect. At least, looking at different time periods seems
appropriate.
Looking at the 25 beta-size portfolios (BESI25), the size effect is already quite
straightforward. As is apparent from table 5 (Panel B), the small portfolios have
higher average returns (0.06 to 0.09) than the big portfolios (0.01 to 0.02). Given

11
their high t-values (and small standard errors), these differences are by far greater
than two standard errors. This size effect was found by Banz 2 as well.
Also for the 25 size-BE/ME portfolios (SIBM25), descriptive statistics are collected
in table 5 (Panel C). The size effect is once more obvious. However, that increasing
BE/ME portfolios exhibit greater returns, as was found by Fama and French 14 , is
not visible, more on the contrary. Since the magnitude of the HMLt (THMLt resp.)
was statistical disappointing already, the overall effect of BE/ME might actually be
limited in this sample.
Inspection of the distribution characteristics of the afore-mentioned portfolio re-
turns gives reasoning to assume “fat tailed” distributions. For IND49 the kurtosis is
greater than three for 42 of 45 portfolio returns. Still the Jarque-Bera null hypothe-
sis that these series are normally distributed cannot be rejected in 24 of 45 cases at
a significance level of 0.01. All of the sorting portfolios, however, clearly exhibit “fat
tails”, since none of them has a kurtosis less or equal than three. The Jarque-Bera
null hypothesis cannot be rejected only in 4 of 10 (BETA10), 4 of 25 (BESI25), and
6 of 25 (SIBM25) cases. This again implies to be careful when interpreting t-values.

3 Results

3.1 Regression Results

The results of the time-series CAPM and Fama and French model for the portfolios
IND49, BETA10, BESI25, and SIBM25 are documented in Appendix A. Most im-
portant is the observation that with the three-factor model the explanatory power
(adjusted R̄2 ) rises in all portfolios, also in those where they do not correspond to
the factor-mimicking factors. This holds not only on average but, actually, there
exists no individual sub-portfolio for which R̄2 falls when adding the SMB and
HML factors in the Fama and French model. The magnitude of the goodness-of-
fit improvement varies, though. The minimal absolute and relative improvement is
recorded for the BETA10 portfolios. The magnitude of R̄2 in the CAPM is already
so high (0.6112) that the Fama and French value of 0.6999 is absolutely higher,
but not that much of advancement. This is not counter-intuitive, since the beta-sort
portfolios are especially built to improve the CAPM predictability. Here it is also
interesting to note that in the three-factor model the beta-sorting is still reflected
by the market beta sensitivity (βM ), which continually grows with the beta deciles.
The largest enhancement of explanatory power can be documented for the SIBM25
portfolios. With 0.7072 the three-factor model shows the absolute and relative high-
est improvement, compared to the CAPM (0.4519). Again, this result is plausible,
because these factor-mimicking portfolios correspond directly to the SMB and HML
regressors.
Besides the goodness-of-fit assessment, the check of the estimated intercepts α̂ is even
more substantial to evaluate the model differences, known as “Jensen ’s alpha” test.
Since in the regression on both sides of the equation excess returns have already been

12
used, the economic expectation is that the intercept of the regression must be zero.
In fact, when studying the regression outputs in Appendix A, all types of portfolios
show the same pattern, namely that in the CAPM α̂ is on average significantly
different from zero, while in the three-factor model it is not. This can be inferred
from the average t-statistics of the α̂ blocks, which are consistently larger than two
standard errors for the CAPM and consistently lower for the Fama and French
model. The “weakest” average CAPM α̂ (2.5552) is documented for the IND49
portfolios, which still holds at least on the 1% level, given the high number of degrees
of freedom for each time-series regression. In turn, the “strongest” average t-value
for the three-factor model is 1.6316 (BESI25) which corresponds to a significance
level greater than 5%. Recalling that returns typically have “fat tails” one could
argue, however, about using critical values of the t-distribution. Yet, the important
fact is that with “fat tails” the inability to reject the null for the three-factor model
is even more assured.
Altogether, these findings allow the conclusion that the Fama and French model out-
performs the CAPM in explaining excess returns statistically (R̄2 ) and economically
(“Jensen ’s alpha” test). This is especially valid for the factor-mimicking portfolios
SIBM25. The power of the three-factor model is not restricted to that, however. On
the contrary, it explains returns more accurately than the CAPM also for the IND49,
BETA10, and BESI25. In other words, the success of the Fama and French models
does not only rely in sorting the portfolios under consideration, but the risk factors
SMB and HML really help in describing the variation of returns. At least empiri-
cally and for the data set at hand this finding is not fully in line with Cochrane 12
who sees the performance of the Fama and French model mainly attributed to using
factor-mimicking portfolios.

3.2 Diagnostic Checks

First, we analyze the robustness of our results by re-calculating the Fama and French
model with the un-trimmed factors, TSMB and THML (not reported). Overall, the
goodness-of-fit does not change considerably. Even though the risk factors perform
slightly less precise, not-rejecting the hypothesis that α is zero for the three-factor
model is still statistically strong.
As a second test, we check the model validity more precisely. Using the return times-
series in regressions, implies that the series are stationary. Applying the ADF-test
again shows that at the firm-level out of the 2766 firm-series the null hypothesis
that the series have a unit root cannot be rejected only in 14 cases on the 0.01
significance level. At the industry-level, all unit root hypotheses can be rejected
at the 0.0001 level. The same holds true for all of the sorting portfolio (BETA10,
BESI25, SIBM25) based time series. Hence, for the following regressions we treat
the returns as stationary. In a next step we check the residuals from the estima-
tions based on the sorting portfolios. We find again strong evidence for heavy tails
and thus, large deviations from normality. However, applying tests for serial corre-
lation and autoregressive conditional heteroskedasticity (ARCH) reveal that there

13
are (almost) no signs for dynamic misspecification. The evidence of fat tails and
extreme observations suggests that we need robust testing procedures in order to
check the stochastic specification of our time-series regressions. We apply a test for
heteroskedasticity based on quantile regressions advocated by Koenker and Bas-
sett 29, 30 . 10 We estimate the Fama and French model in equation (4) using the
method of quantile regression for the median and the lower and upper quartile,
respectively. We then test for slope equality across these regressions. The results,
reported in table 6, suggest that there is strong evidence in favor of the location-
shift hypothesis. This means two things for our empirical analysis. First, there is
strong empirical evidence in favor of the homoskedasticity assumption. Second, the
estimated regression slope parameters of the Fama and French model are relatively
stable over the conditional return distribution (from the lower to the upper quartile).
To be more precise from a formal point of view, the results of our tests indicate that
we can consider quantile regressions of equation (4) under the assumption that the
errors are iid. Then the conditional quantile functions are given by

QRi −Rf (τ |RM − Rf , SMB , HML) =

αi + βiM (RM − Rf ) + βis SMB + βih HML + F −1 εi (τ ), (5)

where Fεi denotes the error distribution function and τ ∈ {0.25, 0.5, 0.75} is the
quantile we wish to estimate. As a consequence, the quantile regression surfaces are
all parallel to each other as the slope parameters do not depend on τ . The regres-
sion intercept, however, estimates αi + F −1 εi (τ ). In other words, for the empirical
results presented here, the mean (OLS) or its robust alternative the median regres-
sion do not only describe the Fama and French relationship “on average” (for the
central part of the return distribution) but fully characterize the Fama and French
relationship also for the lower and the upper part of the return distribution.
The evidence discussed above also suggests that a robust alternative to the mean es-
timator can successfully be used in the Fama and French time-series regression based
on equation (4). In contrast to least squares, median regression is not sensitive to
outliers in the returns. In addition, median regression is superior to mean regression
if the conditional return distribution has fat tails. Hence, we have also calculated the
median (τ = 0.5) regressions for equation (5) for the four different portfolio types.
The results support our findings based on least squares regressions. 11
Place Table 6 about here
Furthermore, we also estimate cross-section and month-by-month regressions to dou-
blecheck the sorting portfolio effect for the CAPM. After having estimated the betas
for each of the portfolios individually (equation 2), the estimated betas and the aver-
age monthly returns are taken to compute the cross-sectional version of the CAPM
for IND49, BETA10, BESI25, and SIBM25 (not reported). The conclusion from the
10 The first application of quantile regression in empirical portfolio analysis is due to
Bassett and Chen 4 .
11 The median regression results are available on request from the corresponding author.

14
cross-sectional regression is that sorting brings in fact differences of how the CAPM
performs. The clear winner is the beta-sorting procedure, which is not surprising,
since these portfolios are explicitly designed to mimic the explaining factor beta.
These observations support that building portfolios, especially based on sorting and
for factor-mimicking portfolios, improves the performance of the CAPM statistically
and economically. In the second alternative regression setup, the cross-sectional re-
gressions from above are not only estimated “on average”, but for each month in the
sample (“month-by-month”). We apply both, the Fama and MacBeth 23 procedure
(“rolling” betas) and the Fama and French 14 concept (“full-period post-ranking
beta”). In total, 11 different regression specifications are estimated, for each proce-
dure separately (not tabulated). Since again other factors than the market return
are superior in explaining the variation in excess returns, the findings support the
conclusions of Fama and French 14 to look for a new model and include additional
risk factors into the CAPM, ultimately leading to a multi-factor model.
Finally, since risk loadings can be time-varying, a sensitivity analysis regarding the
sub-periods is conducted. The results (not reported) show that all in all the inference
is similar to the full period II-IV.

4 Discussion

Asset pricing studies imply three main tasks: (1) The decision on which aggregational
level to perform the estimations, (2) the choice of the asset pricing model, and (3)
how to deal with imprecise factor risk loadings and factor risk premiums.
The central thesis advanced in this paper is that sorting portfolios can highly im-
prove the performance of the models. This especially holds true for factor-mimicking
portfolios and their corresponding models. The Fama and French model dominates
the CAPM in all portfolios studied.
The paper contributes to the literature in four ways. First, to the authors’ knowledge,
this is the first study to consistently assess asset pricing models under the specific
impact of sorting portfolios. Even though there exist studies criticizing the general
applicability of sorting procedures, no study explicitly determined the actual effects
on the models’ performance. Second, our findings clearly support claims toward using
multi-factor models instead of the classic CAPM. Third, we thoroughly investigate
the prerequisites of the empirical specifications of these models. Using a quantile
regression test, we find that our findings (for all sorting portfolios) do not only hold
on average but for large parts of the conditional return distribution, that is there
is a strong empirical evidence in favor of the location-shift hypothesis. Finally, our
study sheds light on the performance of asset pricing models for recent data.
These findings have important implications, but must also be considered with some
caveats. First, applying asset pricing models is more of understanding “whether” and
“how”, and not of “why”. Especially, multi-factor models are a good description but
deliver little explanation of the macroeconomic rationale 12 . Second, regarding the
sorting procedures, one has to acknowledge that there are still other reasons for

15
grouping data than improving the precision of the estimations, e.g. to reduce the
computation effort associated with the size of the financial data set 6 , and voices
that sharply criticize the sorting procedures out of statistical reasons 35 . The final
question is whether to empirically “bury” the CAPM or not. Advocates still hope
the empirically proven failures of the CAPM are due to bad proxies for the market
portfolio, which in contrast also influences the performance of the multi-factor mod-
els. This would mean, to use the words of Fama and French 18 , p. 1956, “the revival
of the CAPM awaits the coming of M .” Even though this seems to be lost hope.

16
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19
5 Graphs

Jun 1993 (167 months) May 2007

BETA10

Beta
90% BESI25

80% Size (ME)

49 2766 SIBM25
industries firms 70%
BE/ME
60% 80%
IND49
50%
40% 60% 80%
30%
20% 60%
40%
10%

20% 40%

20%

realignment each year

Fig. 1. Portfolio construction. This figure illustrates the portfolio construction process.
The firms are initially grouped into industry portfolios (IND49) based on the four-digit
Standard Industrial Classification (SIC) code. The 10 beta-sort portfolios (BETA10) are
based on beta-deciles for which “rolling” betas are calculated. This consumes five years of
pre-estimation data. The remaining sample consists of 167 months of data (July 1993 to
May 2007). By re-aligning each year, 14 years of beta-sort portfolios are calculated. The
25 beta-size portfolios (BESI25) are based upon a two-dimensional sorting. For the beta
dimension every two adjacent deciles are combined into five quintile-beta portfolios. On
the size dimension, a ME sorting is carried out, also discriminating between the quintiles.
The ME value in June of year t is taken to assign the firm into the portfolio year from
July of year t to June of year t + 1. Finally, the overlaps of these two dimensions define
the 25 portfolios. The 25 size-BE/ME portfolios (SIBM25) rely on the same size-sorting.
For the BE/ME dimension, the BE/ME values in December of year t − 1 are assigned to
the 12 month period from July of year t to June of year t + 1.

20
6 Tables

Table 1
Sample selection. This table reports the sample selection process. From the initial 9911
firm observations (COMPUSTAT North America) all non-U.S. firms are excluded. Also
financial firms (SIC 6000-6999) are left out, as well as firms with negative book value.
After some technical corrections 2766 firms remain in the final sample.
COMPUSTAT North America, all firms with SIC codes 9911
./. non-U.S. firms 1193
./. financial firms (SIC 6000-6999) 2729
./. negative book value of equity 2594
./. non-valid data (Returns = “NA”) 376
./. firms with returns greater than 99 33
./. less than 24 monthly data 220
= 2766

Table 2
“Rolling” betas. This table reports the total number of firms used per July-to-June year
for determining the “rolling”betas.
93-94 94-95 95-96 96-97 97-98 98-99 99-00
1,344 1,449 1,536 1,673 1,758 1,957 2,086
00-01 01-02 02-03 03-04 04-05 05-06 06-07
2,238 2,313 2,422 2,501 2,554 2,583 2,647

21
 Table 3: Descriptive statistics of explanatory variables. This table reports descriptive statistics of the explanatory
variables RM , Rf , the trimmed Fama-French factors SMB and HML, as well as the un-trimmed factors TSMB and THML.
Mean, standard deviation (Std), Standard error (SE), t-statistic of mean (t) and the number of observations (Obs) are given
for the total sample, as well as for 4 sub-periods. The cross-correlations are stated for the full sample.

Full sample: 1988M07-2007M05 Cross-Correlations (full sample)

Mean Std SE t() Obs RM Rf SMB TSMB HML THML
RM 0.0273 0.0570 0.0038 7.20 227 1
Rf 0.0441 0.0193 0.0013 34.37 227 -0.1959 1
SMB 0.0272 0.0611 0.0041 6.72 227 0.1837 -0.1299 1
TSMB 0.0291 0.0643 0.0043 6.81 227 0.1792 -0.1342 0.9954 1
HML -0.0021 0.0464 0.0031 -0.69 227 -0.3086 -0.1484 -0.3955 -0.3950 1
THML -0.0009 0.047 0.0031 -0.30 227 -0.3042 -0.1748 -0.3930 -0.3822 0.9863 1

Sub-period I: 1988M07-1993M06 Sub-period II: 1993M07-1998M06

Mean Std SE t() Obs Mean Std SE t() Obs

22
RM 0.0129 0.0355 0.0046 2.82 60 0.0204 0.0303 0.0039 5.21 60
Rf 0.0590 0.0203 0.0026 22.46 60 0.0477 0.0080 0.0010 46.45 60
SMB 0.0147 0.0350 0.0045 3.24 60 0.0175 0.0324 0.0042 4.18 60
TSMB 0.0158 0.0360 0.0046 3.41 60 0.0175 0.0337 0.0043 4.02 60
HML -0.0039 0.0305 0.0039 -0.99 60 -0.0032 0.0262 0.0034 -0.94 60
THML -0.0037 0.0307 0.0040 -0.93 60 -0.0033 0.0257 0.0033 -0.99 60

Sub-period III: 1998M07-2003M06 Sub-period IV: 2003M07-2007M05

Mean Std SE t() Obs Mean Std SE t() Obs
RM 0.0322 0.0776 0.0100 3.21 60 0.0480 0.0683 0.01 4.82 47
Rf 0.0364 0.0176 0.0023 16.05 60 0.0304 0.0159 0.0023 13.09 47
SMB 0.0498 0.1009 0.0130 3.83 60 0.0269 0.0367 0.0054 5.02 47
TSMB 0.0533 0.1065 0.0137 3.88 60 0.0298 0.0384 0.0056 5.32 47
HML -0.0097 0.0705 0.0091 -1.07 60 0.0111 0.0436 0.0064 1.75 47
THML -0.0067 0.0729 0.0094 -0.72 60 0.0130 0.0414 0.0060 2.15 47
 Table 4: Descriptive statistics of industries (IND49). This table reports descriptive statistics of the industries
(IND49) for July 1987 - May 2007. The mean return (RIND ), the standard deviation (Std), the t-statistic (t), the time-series
beta (Beta) and the average number of observations per month (Obs) are given for all 45 industry portfolios.

RIND Std t(RIND ) Beta Size in % Obs RIND Std t(RIND ) Beta Size in % Obs
Ind1 0.01 0.06 2.65 0.61 0.39 8.9 Ind24 0.01 0.06 3.40 0.98 3.52 13.2
Ind2 0.01 0.04 3.88 0.52 1.55 47.3 Ind25 0.01 0.06 3.06 0.87 1.11 5.8
Ind3 0.01 0.07 2.29 0.86 1.04 6.2 Ind26 0.01 0.07 2.67 0.42 1.79 4.4
Ind4 0.01 0.05 3.67 0.61 10.32 9.1 Ind27 0.01 0.14 1.59 0.89 0.08 6.1
Ind5 0.01 0.08 2.54 0.55 34.71 1.4 Ind28 0.02 0.07 4.66 0.85 0.75 8.1
Ind6 0.02 0.07 3.97 0.88 0.39 17.8 Ind29 0.02 0.11 2.33 0.63 0.57 1.7
Ind7 0.02 0.08 3.43 1.33 0.67 29.5 Ind30 0.01 0.05 3.92 0.65 2.15 84.5
Ind8 0.01 0.04 3.27 0.79 1.36 22.9 Ind31 0.01 0.04 3.24 0.40 1.52 116.5
Ind9 0.01 0.04 4.65 0.67 1.73 46.2 Ind32 0.01 0.05 3.50 0.91 4.65 34.5

23
Ind10 0.02 0.06 4.88 1.03 0.41 44.7 Ind33 0.02 0.05 4.79 0.78 0.49 20.4
Ind11 0.02 0.07 4.80 0.69 0.37 35.5 Ind34 0.02 0.05 5.91 1.02 0.53 104.9
Ind12 0.02 0.05 5.84 0.78 0.76 61.0 Ind35 0.02 0.09 4.00 1.72 2.90 46.6
Ind13 0.01 0.05 4.64 0.70 3.21 99.0 Ind36 0.02 0.08 3.93 1.46 2.04 110.0
Ind14 0.01 0.05 3.02 0.92 1.62 46.1 Ind37 0.02 0.09 3.99 1.71 1.24 141.7
Ind15 0.01 0.06 3.63 0.73 0.27 19.3 Ind38 0.02 0.08 4.11 1.55 0.34 65.3
Ind16 0.01 0.07 3.07 1.00 0.23 10.1 Ind39 0.01 0.05 3.16 0.77 1.63 33.2
Ind17 0.01 0.05 3.36 0.96 0.53 50.5 Ind40 0.01 0.05 3.35 0.76 0.82 6.4
Ind18 0.02 0.07 4.28 1.20 0.39 31.9 Ind41 0.01 0.05 4.14 0.88 1.09 53.8
Ind19 0.02 0.07 3.54 1.27 0.68 32.7 Ind42 0.02 0.04 5.61 0.82 0.46 81.8
Ind20 0.02 0.06 4.28 0.84 0.07 9.9 Ind43 0.02 0.06 5.00 0.98 1.92 117.4
Ind21 0.02 0.06 4.30 1.26 0.73 71.5 Ind44 0.02 0.05 4.44 0.87 0.84 41.3
Ind22 0.01 0.05 4.00 0.93 0.52 44.6 Ind49 0.01 0.05 3.91 0.96 6.10 26.4
Ind23 0.01 0.07 1.87 1.07 1.53 37.1 Total 100 1923
Table 5
Descriptive statistics of portfolios BETA10, BESI25, and SIBM25. This table
reports the descriptive statistics for the sorting portfolios BETA10, BESI25 and SIBM25
from July 1993 - May 2007. The mean return (R̄p ), the standard deviation (Std), the
t-statistic (t) and the number of observations (Obs) are given for all portfolios. The full-
period post-ranking beta (β̂p ) is stated for the BETA10 portfolios.
Panel A: BETA10
Beta
Low 2 3 4 5 6 7 8 9 High
R̄p 0.02 0.01 0.01 0.02 0.02 0.02 0.02 0.02 0.02 0.03
Std 0.04 0.04 0.04 0.04 0.04 0.04 0.05 0.06 0.07 0.10
t(R̄p ) 5.52 3.75 3.3 5.43 5.01 6.15 4.02 3.80 3.53 3.33
Size in % 4.32 9.31 12.01 13.25 13.32 12.94 9.74 10.48 9.70 4.92
Obs 207.7 207.6 207.2 206.7 206.8 206.7 206.9 207.2 207.4 208.0
β̂p 0.54 0.69 0.60 0.70 0.75 0.82 1.18 1.28 1.51 2.00

Panel B: BESI25
Beta
Size Low 2 3 4 High Low 2 3 4 High
R̄p t(R̄p )
Small 0.08 0.07 0.06 0.07 0.09 8.84 7.22 9.29 6.65 7.62
2 0.04 0.04 0.05 0.05 0.05 7.30 5.81 7.43 6.92 6.63
3 0.02 0.03 0.04 0.03 0.04 7.09 6.34 6.76 6.09 5.41
4 0.02 0.02 0.02 0.03 0.03 6.55 5.99 6.06 6.29 5.08
Big 0.01 0.01 0.02 0.02 0.02 4.39 4.40 5.34 3.72 3.28

Size in % Obs
Small 0.03 0.03 0.02 0.02 0.03 105.1 64.6 65.4 68.0 79.9
2 0.11 0.11 0.12 0.12 0.12 88.9 75.9 62.1 66.7 80.7
3 0.37 0.38 0.40 0.39 0.38 62.0 75.7 72.5 80.3 84.5
4 1.23 1.28 1.33 1.30 1.27 61.1 83.0 87.7 85.6 69.1
Big 16.25 22.25 19.38 16.79 16.29 60.9 86.3 101.8 89.1 64.3

Panel C: SIBE25
BE/ME
Size Low 2 3 4 High Low 2 3 4 High
R̄p t(R̄p )
Small 0.09 0.08 0.07 0.06 0.08 8.29 5.96 8.64 8.57 8.72
2 0.05 0.05 0.05 0.04 0.06 5.73 6.62 6.54 8.19 5.70
3 0.04 0.04 0.03 0.03 0.03 5.18 5.89 6.54 6.52 7.16
4 0.03 0.02 0.02 0.02 0.02 5.41 5.49 6.51 5.90 5.94
Big 0.02 0.02 0.02 0.01 0.02 4.56 4.88 5.07 3.62 4.76

Size in % Obs
Small 0.04 0.03 0.03 0.03 0.03 47.7 45.0 55.3 85.3 175.7
2 0.13 0.14 0.14 0.14 0.13 66.8 62.5 73.5 95.9 112.6
3 0.45 0.46 0.46 0.46 0.43 71.8 86.8 103.3 92.9 55.9
4 1.54 1.52 1.48 1.47 241.52 90.6 108.9 102.6 78.5 33.4
Big 33.20 18.62 14.21 12.98 10.36 137.1 111.4 79.9 59.7 30.3
Table 6
Slope Equality Test. This table reports the Slope Equality (Wald) Test for regression
quartiles of the IND49, the BETA10, the BESI25 and the SIBM25 portfolios. The portfolio-
specific p-values for the hypothesis H0 : β (0.25) = β (0.5) = β (0.75) are given.
Panel A: IND49
0.89 0.24 0.66 0.05 0.48
0.05 0.85 0.60 1.00 0.67
0.37 0.90 0.89 0.27 0.38
0.00 0.20 0.79 0.03 0.09
0.98 0.06 0.02 0.35 0.42
0.33 0.72 0.72 0.65 0.14
0.97 0.76 0.37 0.81 0.17
0.62 0.71 0.07 0.29 1.00
0.66 0.53 0.05 0.09 0.18

Panel B: BETA10
0.86 0.12 0.97 0.62 0.17
0.16 0.13 0.60 0.03 0.81

Panel C: BESI25
0.48 0.43 0.09 0.13 0.08
0.39 0.15 0.48 0.30 0.74
0.26 0.08 0.20 0.19 0.16
0.42 0.73 0.28 0.75 0.01
0.32 0.30 0.49 0.08 0.83

Panel D: SIBM25
0.00 0.34 0.00 0.35 0.54
0.03 0.82 0.03 0.72 0.39
0.91 0.56 0.01 0.22 0.34
0.61 0.24 0.39 0.17 0.03
0.78 0.47 0.78 0.45 0.99

A Time-series CAPM and Fama-French model

25
 Table A.1: IND49 - CAPM. This table reports the CAPM regressions with estimated parameters for the industries
(IND49) from July 1993 - May 2007. The estimated parameters (α̂ and β̂), their t-values (t) and the adjusted R̄2 are given.
The t-value averages are derived from absolute values.

Industries α̂ (average: -0.0049) t(α̂) (average: 2.5552)

IND01 IND02 IND03 IND04 IND05 -0.02 -0.02 -0.01 -0.02 -0.02 -3.86 -6.30 -1.39 -4.48 -2.27
IND06 IND07 IND08 IND09 IND10 -0.01 0.00 -0.01 -0.01 0.00 -1.71 0.78 -5.10 -4.45 0.51
IND11 IND12 IND13 IND14 IND15 -0.01 -0.01 -0.01 -0.01 -0.01 -1.35 -1.98 -3.08 -2.22 -3.28
IND16 IND17 IND18 IND19 IND20 -0.01 -0.01 0.01 0.01 -0.01 -1.15 -2.09 1.19 1.85 -1.15
IND21 IND22 IND23 IND24 IND25 0.01 -0.01 -0.01 0.00 -0.01 2.87 -1.46 -1.46 -0.71 -1.95
IND26 IND27 IND28 IND29 IND30 -0.02 0.00 0.00 -0.01 -0.01 -3.39 -0.04 0.47 -0.80 -2.91
IND31 IND32 IND33 IND34 IND35 -0.02 -0.01 -0.01 0.00 0.03 -6.60 -2.71 -1.55 0.96 5.26
IND36 IND37 IND38 IND39 IND40 0.02 0.03 0.02 -0.01 -0.01 4.89 5.16 4.85 -4.04 -2.53

26
IND41 IND42 IND43 IND44 IND49 -0.01 -0.01 0.00 -0.01 -0.01 -2.85 -2.57 -0.51 -2.28 -1.98

β̂ (average: 0.8576) t(β̂) (average: 9.5428) R̄2 (average: 0.3359)

0.47 0.35 0.64 0.48 0.43 4.56 4.69 4.69 5.26 2.73 0.11 0.11 0.11 0.14 0.04
0.76 1.27 0.67 0.55 0.92 7.00 12.03 10.88 7.67 9.86 0.22 0.46 0.41 0.26 0.37
0.44 0.64 0.59 0.87 0.61 3.75 9.77 7.97 10.48 6.78 0.07 0.36 0.27 0.40 0.21
0.91 0.90 1.13 1.34 0.80 7.83 11.89 11.13 12.72 8.58 0.27 0.46 0.43 0.49 0.30
1.32 0.89 1.08 0.95 0.70 18.41 11.56 10.84 9.74 6.69 0.67 0.44 0.41 0.36 0.21
0.19 1.06 1.00 0.66 0.63 1.39 3.84 8.91 2.91 7.28 0.01 0.08 0.32 0.04 0.24
0.29 0.91 0.64 1.00 1.84 3.59 13.36 6.77 22.30 17.15 0.07 0.52 0.21 0.75 0.64
1.63 1.89 1.69 0.69 0.72 17.70 17.19 16.17 9.10 7.26 0.65 0.64 0.61 0.33 0.24
0.79 0.71 0.90 0.75 0.89 11.24 12.43 11.39 9.70 12.24 0.43 0.48 0.44 0.36 0.47
 Table A.2: IND49 - Fama-French. This table reports the Fama-French regressions with estimated parameters for the
industries (IND49) from July 1993 - May 2007. The estimated parameters (α̂, β̂M , β̂s and β̂h ), their t-values (t) and the
adjusted R̄2 are given. The t-value averages are derived from absolute values.

α̂ (average: -0.0014) t(α̂) (average: 1.4401) β̂M (average: 0.9561)

-0.01 -0.01 0.00 -0.01 -0.01 -2.37 -3.20 -0.35 -2.23 -1.19 0.65 0.54 0.81 0.64 0.59
0.00 -0.01 -0.01 0.00 0.01 -0.78 -1.49 -2.59 -1.30 2.54 0.90 1.15 0.81 0.69 1.12
-0.01 0.00 0.00 0.00 -0.01 -1.37 -1.15 -1.18 0.67 -1.39 0.54 0.66 0.64 1.09 0.78
0.00 0.00 0.01 0.01 -0.01 -0.71 0.61 1.41 2.33 -1.81 1.02 1.10 1.21 1.45 0.82
0.01 0.00 0.00 0.01 0.00 1.66 -0.89 0.40 1.94 0.52 1.31 0.96 1.29 1.21 0.93
-0.01 -0.01 0.01 -0.01 0.00 -1.94 -0.87 1.41 -0.78 -0.98 0.39 1.06 1.15 0.81 0.80
-0.02 0.00 0.00 0.00 0.02 -4.55 -0.64 -0.55 1.19 3.01 0.50 0.99 0.75 1.03 1.65
0.01 0.01 0.00 0.00 0.00 3.27 1.99 0.99 -1.03 -0.64 1.44 1.63 1.38 0.88 0.95
0.00 -0.01 0.00 0.00 0.01 -0.71 -1.66 0.87 0.17 1.46 0.97 0.77 1.00 0.95 1.03

t(β̂M ) (average: 10.4545) β̂s (average: -0.0346) t(β̂s ) (average: 2.1790)

6.14 7.25 5.65 6.92 3.45 -0.05 -0.20 -0.06 -0.15 -0.09 -0.76 -4.26 -0.68 -2.49 -0.88
7.80 10.60 13.04 9.83 11.86 -0.02 0.30 -0.11 -0.22 -0.16 -0.34 4.37 -2.84 -4.91 -2.64

27
4.39 9.18 8.11 13.82 8.42 0.12 -0.05 -0.16 -0.19 -0.10 1.52 -1.15 -3.24 -3.77 -1.79
8.30 15.10 11.04 12.75 8.18 0.04 -0.15 0.00 -0.05 0.14 0.46 -3.33 0.01 -0.65 2.28
16.89 11.70 12.71 12.88 8.98 0.10 0.01 -0.12 -0.19 -0.21 1.98 0.17 -1.92 -3.27 -3.18
2.72 3.58 9.62 3.31 9.00 -0.09 0.41 -0.07 0.16 -0.11 -0.98 2.17 -0.98 1.01 -1.93
6.72 13.77 7.42 21.18 14.86 -0.07 -0.14 -0.04 0.00 0.16 -1.55 -3.18 -0.69 -0.12 2.34
15.58 15.24 14.74 12.11 9.66 0.04 0.31 0.37 -0.19 -0.10 0.70 4.58 6.31 -4.10 -1.54
14.20 12.53 11.98 12.58 14.67 -0.08 -0.01 -0.10 -0.13 -0.27 -1.94 -0.30 -1.82 -2.78 -6.14

β̂h (average: 0.1843) t(β̂h ) (average: 2.8517) R̄2 (average: 0.4059)

0.35 0.19 0.33 0.22 0.25 3.90 3.01 2.69 2.75 1.69 0.20 0.28 0.16 0.23 0.06
0.28 0.07 0.18 0.09 0.27 2.87 0.76 3.48 1.52 3.39 0.26 0.52 0.50 0.39 0.45
0.36 -0.02 -0.07 0.30 0.27 3.44 -0.36 -1.03 4.38 3.37 0.13 0.36 0.31 0.54 0.30
0.30 0.28 0.18 0.18 0.19 2.89 4.50 1.94 1.90 2.26 0.30 0.58 0.43 0.50 0.33
0.08 0.18 0.33 0.37 0.30 1.19 2.54 3.79 4.57 3.39 0.68 0.46 0.49 0.50 0.34
0.36 0.44 0.25 0.50 0.26 2.91 1.75 2.46 2.40 3.42 0.07 0.10 0.35 0.06 0.33
0.41 0.02 0.20 0.06 -0.25 6.39 0.33 2.31 1.53 -2.67 0.30 0.55 0.24 0.75 0.67
-0.39 -0.27 -0.30 0.23 0.41 -4.91 -2.92 -3.74 3.70 4.89 0.70 0.71 0.74 0.48 0.37
0.31 0.12 0.13 0.30 0.02 5.29 2.24 1.82 4.61 0.39 0.55 0.49 0.46 0.49 0.58
 Table A.3: BETA10 - CAPM and Fama-French. This table reports the CAPM and the Fama-French regressions with
estimated parameters for the BETA10 portfolios from July 1993 - May 2007. The estimated parameters (α̂, β̂ and α̂, β̂M , β̂s ,
β̂h respectively), their t-values (t) and the adjusted R̄2 are given. The t-value averages are derived from absolute values.

Panel A: BETA10 - CAPM

beta
Low 2 3 4 5 6 7 8 9 High Average
α̂ -0.01 -0.01 -0.02 -0.01 -0.01 0.00 0.00 0.01 0.01 0.03 -0.00
t(α̂) -3.29 -5.11 -6.77 -3.77 -3.23 -1.65 1.39 2.41 4.26 6.23 3.81
β̂ 0.54 0.69 0.60 0.70 0.75 0.82 1.18 1.28 1.51 2.00 1.01
t(β̂) 8.23 13.22 11.31 14.95 14.93 20.26 25.98 23.14 22.76 19.78 17.46
R̄2 0.29 0.51 0.43 0.57 0.57 0.71 0.80 0.76 0.76 0.70 0.61

28
Panel B: BETA10 - Fama-French

α̂ 0.00 -0.01 -0.01 0.00 0.00 0.00 0.00 0.00 0.00 0.02 0.00
t(α̂) -0.69 -2.03 -3.30 0.05 1.15 1.22 1.57 1.24 0.73 3.18 1.52
β̂M 0.70 0.83 0.75 0.83 0.91 0.92 1.18 1.28 1.32 1.75 1.05
t(β̂M ) 10.92 16.50 15.24 19.62 21.63 23.36 23.84 21.42 21.53 17.82 19.19
β̂s -0.13 -0.13 -0.16 -0.17 -0.19 -0.10 -0.03 0.08 0.21 0.26 -0.04
t(β̂s ) -3.14 -4.24 -5.32 -6.16 -7.21 -4.02 -0.98 2.15 5.39 4.12 4.27
β̂h 0.22 0.16 0.15 0.12 0.16 0.12 -0.03 0.08 -0.19 -0.28 0.05
t(β̂h ) 4.08 3.73 3.70 3.37 4.58 3.42 -0.79 1.53 -3.56 -3.30 3.21
R̄2 0.42 0.62 0.59 0.70 0.74 0.77 0.80 0.77 0.82 0.76 0.70
 Table A.4: BESI25 - CAPM. This table reports the CAPM regressions with estimated parameters for the BESI25
portfolios from July 1993 - May 2007. The estimated parameters (α̂ and β̂), their t-values (t), the adjusted R̄2 and the
standard error of regression (s(ε̂t )) are given. The t-value averages are derived from absolute values.

beta
Size Low 2 3 4 High Low 2 3 4 High Low 2 3 4 High
α̂ (average: 0.0252) t(α̂) (average: 4.6716) β̂ (average: 1.1732)
Small 0.07 0.06 0.05 0.06 0.09 7.40 6.09 7.31 5.06 8.73 1.30 1.35 1.17 1.20 2.11
2 0.02 0.03 0.04 0.04 0.05 3.06 3.97 5.89 5.84 7.02 0.77 1.16 1.23 1.34 1.66
3 0.00 0.01 0.02 0.02 0.04 0.57 1.69 5.06 4.28 7.00 0.75 0.87 1.18 1.18 1.84

29
4 0.00 0.00 0.00 0.01 0.03 -2.02 -1.05 1.84 4.68 6.21 0.69 0.81 0.98 1.14 1.59
Big -0.01 -0.01 -0.01 0.00 0.02 -5.22 -6.03 -3.51 2.08 5.18 0.67 0.64 0.77 1.25 1.68

t(β̂) (average: 12.8356) R̄2 (average: 0.4517) s(ε̂t ) (average: 0.0601)

Small 6.09 6.23 7.81 4.97 9.17 0.18 0.19 0.27 0.12 0.33 0.11 0.12 0.08 0.13 0.12
2 6.48 6.96 8.37 9.03 10.48 0.20 0.22 0.29 0.33 0.40 0.06 0.09 0.08 0.08 0.08
3 10.91 10.85 12.58 12.97 13.42 0.42 0.41 0.49 0.50 0.52 0.04 0.04 0.05 0.05 0.07
4 13.13 15.53 17.26 20.61 16.39 0.51 0.59 0.64 0.72 0.62 0.03 0.03 0.03 0.03 0.05
Big 13.66 13.84 18.12 32.85 23.18 0.53 0.53 0.66 0.87 0.76 0.03 0.02 0.02 0.02 0.04
 Table A.5: BESI25 - Fama-French. This table reports the Fama-French regressions with estimated parameters for the
BESI25 portfolios from July 1993 - May 2007. The estimated parameters (α̂, β̂M , β̂s and β̂h ), their t-values (t) and the
adjusted R̄2 are given. The t-value averages are derived from absolute values.

beta
Size Low 2 3 4 High Low 2 3 4 High Low 2 3 4 High
α̂ (average: 0.0044) t(α̂) (average: 1.6316) β̂M (average: 0.9800)
Small 0.03 0.01 0.02 0.03 0.03 3.07 1.12 3.50 0.83 4.03 0.73 0.66 0.94 1.14 1.36
2 0.00 -0.01 0.00 0.00 0.01 -0.59 -0.90 0.16 0.11 1.31 0.67 0.86 0.80 1.55 1.03
3 -0.01 -0.01 0.00 0.00 0.00 -1.85 -3.07 -0.78 -1.41 1.07 0.70 0.71 0.88 0.92 1.27
4 -0.01 -0.01 0.00 0.01 0.01 -2.43 -1.90 0.30 3.08 1.71 0.73 0.83 0.98 1.14 1.29
Big 0.00 0.00 0.00 0.00 0.01 -1.21 -1.60 1.24 1.35 2.17 0.83 0.80 0.91 1.23 1.49

30
t(β̂M ) (average: 13.0564) β̂s (average: 0.5792) t(β̂s ) (average: 8.7408)
Small 3.99 3.87 6.79 1.54 8.50 1.04 1.15 0.70 1.67 1.42 8.96 10.80 8.07 3.58 14.06
2 6.17 6.32 7.84 5.95 11.35 0.58 0.97 0.96 1.83 1.00 8.51 11.36 14.83 11.16 17.43
3 10.26 10.19 13.20 13.40 17.81 0.24 0.42 0.57 0.54 0.89 5.43 9.66 13.58 12.55 19.69
4 13.28 15.48 16.59 19.36 15.96 0.09 0.11 0.13 0.10 0.45 2.50 3.13 3.59 2.74 8.92
Big 19.54 21.10 26.67 29.68 21.57 -0.18 -0.20 -0.18 0.01 0.17 -6.77 -8.49 -8.20 0.55 3.96

β̂h (average: 0.0824) t(β̂h ) (average: 2.8196) R̄2 (average: 0.6523)

Small -0.14 -0.31 0.25 -0.30 -0.14 -0.89 -2.15 2.12 -0.47 -1.00 0.48 0.58 0.47 0.12 0.73
2 0.39 0.38 0.07 1.68 -0.32 4.27 3.32 0.75 7.56 -4.09 0.44 0.56 0.71 0.53 0.83
3 0.16 0.09 -0.04 0.00 -0.30 2.80 1.58 -0.73 0.07 -4.94 0.50 0.63 0.78 0.76 0.89
4 0.18 0.18 0.15 0.11 -0.18 3.85 3.84 3.01 2.19 -2.58 0.55 0.63 0.67 0.73 0.78
Big 0.16 0.13 0.14 -0.03 -0.25 4.36 4.09 4.71 -0.81 -4.31 0.70 0.74 0.81 0.87 0.82
 Table A.6: SIBM25 - CAPM. This table reports the CAPM regressions with estimated parameters for the SIBM25
portfolios from July 1993 - May 2007. The estimated parameters (α̂ and β̂), their t-values (t), the adjusted R̄2 and the
standard error of regression (s(ε̂t )) are given. The t-value averages are derived from absolute values.

BE/ME
Size Low 2 3 4 High Low 2 3 4 High Low 2 3 4 High
α̂ (average: 0.0260) t(α̂) (average: 4.3960) β̂ (average: 1.1792)
Small 0.10 0.07 0.06 0.05 0.06 8.56 5.14 8.27 6.57 7.07 1.92 1.48 1.47 1.17 1.22
2 0.04 0.05 0.03 0.02 0.05 5.68 6.01 5.22 5.56 4.36 1.61 1.44 1.27 1.06 1.28
3 0.04 0.03 0.01 0.01 0.02 6.30 5.70 3.78 3.05 4.24 1.69 1.46 1.07 0.99 1.06

31
4 0.02 0.01 0.00 0.00 0.01 5.51 3.05 1.29 0.85 1.55 1.36 1.12 0.90 0.89 0.93
Big 0.00 0.00 -0.01 -0.01 -0.01 -0.14 -1.28 -2.88 -4.74 -3.10 1.05 0.97 0.79 0.68 0.60

t(β̂) (average: 13.1504) R̄2 (average: 0.4519) s(ε̂t ) (average: 0.0608)

Small 7.86 5.13 9.48 7.69 6.32 0.27 0.13 0.35 0.26 0.19 0.13 0.15 0.08 0.08 0.10
2 9.56 8.89 9.07 11.14 5.45 0.35 0.32 0.33 0.43 0.15 0.09 0.09 0.07 0.05 0.13
3 14.11 11.23 13.20 13.13 12.61 0.54 0.43 0.51 0.51 0.49 0.06 0.07 0.04 0.04 0.04
4 18.31 17.80 16.36 14.14 11.74 0.67 0.66 0.62 0.55 0.45 0.04 0.03 0.03 0.03 0.04
Big 39.42 29.40 16.73 11.72 8.27 0.90 0.84 0.63 0.45 0.29 0.01 0.02 0.03 0.03 0.04
 Table A.7: SIBM25 - Fama-French. This table reports the Fama-French regressions with estimated parameters for the
SIBM25 portfolios from July 1993 - May 2007. The estimated parameters (α̂, β̂M , β̂s and β̂h ), their t-values (t) and the
adjusted R̄2 are given. The t-value averages are derived from absolute values.

BE/ME
Size Low 2 3 4 High Low 2 3 4 High Low 2 3 4 High
α̂ (average: 0.0040) t(α̂) (average: 1.3972) β̂M (average: 0.9404)
Small 0.05 -0.01 0.03 0.01 0.01 4.61 -0.99 4.13 1.45 1.95 1.41 0.38 1.04 0.71 0.66
2 0.00 0.00 -0.01 0.00 0.01 -0.41 -0.94 -1.90 0.47 1.13 0.95 0.83 0.74 0.86 1.35
3 0.00 0.00 0.00 -0.01 0.00 0.51 -1.00 -1.42 -2.00 0.57 1.18 0.93 0.86 0.84 0.98
4 0.01 0.00 0.00 0.00 0.01 1.54 -0.87 0.98 -1.07 1.84 1.15 0.99 0.95 0.90 1.08
Big 0.00 0.00 0.00 0.00 0.00 1.04 1.29 -0.97 -1.53 0.32 1.03 1.04 0.90 0.89 0.86

32
t(β̂M ) (average: 13.7984) β̂s (average: 0.5520) t(β̂s ) (average: 9.6288)
Small 6.32 2.03 7.72 6.20 4.69 1.12 1.69 0.71 0.89 1.20 7.91 14.21 8.36 12.33 13.44
2 9.04 9.81 9.38 11.80 7.65 1.00 1.13 0.93 0.60 1.31 15.08 21.18 18.82 12.94 11.78
3 17.01 13.00 13.15 13.49 12.98 0.69 0.82 0.45 0.43 0.41 15.66 18.25 11.01 11.03 8.71
4 17.24 16.91 16.38 14.04 13.91 0.29 0.27 0.06 0.20 0.08 6.83 7.40 1.58 4.86 1.60
Big 38.43 31.72 19.24 18.55 14.27 -0.07 -0.07 -0.05 -0.13 -0.16 -3.88 -3.61 -1.54 -4.36 -4.35

β̂h (average: 0.0632) t(β̂h ) (average: 3.7584) R̄2 (average: 0.7072)

Small 0.08 -0.63 -0.19 -0.07 0.04 0.41 -3.92 -1.63 -0.68 0.36 0.48 0.69 0.58 0.65 0.64
2 -0.40 -0.14 -0.19 0.20 1.58 -4.42 -1.94 -2.89 3.16 10.48 0.79 0.84 0.82 0.72 0.59
3 -0.39 -0.29 0.03 0.13 0.28 -6.50 -4.78 0.61 2.41 4.31 0.87 0.85 0.73 0.72 0.65
4 -0.17 0.01 0.18 0.21 0.42 -3.06 0.13 3.54 3.92 6.34 0.78 0.75 0.64 0.61 0.56
Big -0.11 0.08 0.19 0.33 0.40 -4.85 2.93 4.89 7.96 7.84 0.92 0.86 0.69 0.68 0.59