On the robustness of the market value of equity as risk absorber in cross-sectional regressions

Abstract

We reexamine the role of the market value of equity (MVE) and the book to market equity ratio (B/M) by comparing models used in Fama and French (FF) (1992) with models derived from the discounted dividend model (DDM) and Berk's (l 995) assertion. We apply Knez and Ready's ( 1997) estimation methodologies to data from the Japanese stock market, and assess the robustness of MVE in the two types of models. Similar to the U.S. case, when FF's models are used, the risk premium on MVE disappears when only I percent of the observations is trimmed On the contrary, when we follow DOM and use book equity as a control variable, MVE remains highly significant even for' trimming proportions of 50 percent. Altogether, the use of DOM allows us to find evidence that MVE absorbs risk, and a viable explanation for the B/M anomaly.