Australian firm characteristics and the cross-section variation in equity returns

• Firm characteristics size, book to market and cash flows explain the cross-section of equity returns
• Large sample of Australian listed companies covering a 20 year period, 1993 to 2012
• Application of the Brennan et al. (1998) approach in analysis
• Use of the both Fama and French 3-factor and 5-factor models to adjust for risk.

Drawing on the work of Fama and French (1992) and Hou et al. (2011), this study tests the explanatory power of firm characteristics over expected returns for a large sample of Australian firms spanning the period from 1993 to 2012. Consistent with Hou et al. (2011), we find support for size and cash flows for both the full study period and the pre global financial crisis period. There are three significant aspects of this work. First, the impact of some firm characteristics appears sensitive to sample period. We find a premium to firms paying dividends during the pre-global financial crisis (GFC) period, suggesting that franking credits are valuable to Australian shareholders. This is not strongly supported for the full sample. We also observe evidence of a premium to unlevered stocks for the full study period, which is not evident in the pre-GFC period. Second, we use the Fama and French (2015) five factor model to adjust for risk and compare the results with the benchmark Fama and French (1992, 1993) three factor model. Finally, to address the errors-in-variables (EIV) problem, we focus on the risk correction approach developed by Brennan et al. (1998), instead of the traditional Fama and MacBeth (1973) approach.