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Yield Spreads as Alternative Risk Factors for Size and Book-to-Market

Published online by Cambridge University Press:  06 April 2009

Jaehoon Hahn  and
Hangyong Lee
Jaehoon Hahn
Affiliation:
hahnj@u.washington.edu, University of Washington Business School, 320 Mackenzie Hall, Seattle, WA 98195
Hangyong Lee
Affiliation:
hlee@kdi.re.kr, Korea Development Institute, 207-41 Cheongyang, Dongdaemun-gu, Seoul, Korea, 130-012.
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Abstract

This paper investigates whether the size and book-to-market factors of Fama and French (1993) proxy for the risks associated with business cycle fluctuations. We find that changes in default spread (Δdef) and changes in term spread (Δterm) capture the systematic differences in average returns along the size and book-to-market dimensions in the way that the Fama-French factors do: small stock portfolios have higher loadings on Δdef than large stock portfolios, while high book-to-market portfolios have higher loadings on Δterm than low book-to-market portfolios. Furthermore, in the presence of Δdef and Δterm, the Fama-French factors are superfluous in explaining the size and book-to-market effects. The results suggest that the size and value premiums are compensation for higher exposure to the risks related to changing credit market conditions and interest rates proxied by Δdef and Δterm.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 41 , Issue 2 , June 2006 , pp. 245 - 269
Copyright
Copyright © School of Business Administration, University of Washington 2006

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