You can find this information by choosing a company, then clicking on the Financial Hlts. link in the Compustat Reports section. Rank the firms based on each of the criteria separately and divide the firms into five groups based on their ranking for each criterion. Calculate the average rate of return for each group of firms.
Do you confirm or reject any of the anomalies cited in this chapter? Can you uncover a new anomaly? Note: For your test to be valid, you must form your portfolios based on criteria observed at the beginning of the period when you form the stock groups. Why?
Use the price history supplied by Market Insight (www.mhhe.com/edumarketinsight) to calculate the beta of each of the firms in the previous question. Use this beta, the T-bill rate, and the return on the S&P 500 to calculate the risk-adjusted abnormal return of each stock group. Does any anomaly uncovered in the previous question persist after controlling for risk?
Now form stock groups that use two criteria simultaneously. For example, form a portfolio of stocks that are both in the lowest quintile of price-earnings ratios and in the lowest quintile of market-to-book ratio. Does selecting stocks based on more than one characteristic improve your ability to devise portfolios with abnormal returns? Repeat the analysis by forming groups that meet three criteria simultaneously. Does this yield any further improvement in abnormal returns?
