The Relation Between Firm Characteristics And Stock Returns

A large number of empirical studies have shown that the expected return of stock research has a wide range of important applications in the financial field,including testing asset pricing models,designing trading strategies and the cost of capital for decision-making companies.The characteristic variables of stocks include firm size,book-to-market ratio,return on assets and profitability indicators,which are all related to the expected return of stocks.The results of these studies are ubiquitous in the existing literature,thus fully demonstrating that these phenomenas are not caused by randomness or due to data manipulation errors.The article by Lewellen(The cross section of expected stock returns,2015)shows that there are some correlations between the different characteristic variables that affect the expected return of stocks.Some of the indicators reflect the same characteristics of the stocks,such as asset growth and accruals,they both reflect the company's growth characteristics.Also,different profitability indicators are the same reflection of the profitability characteristics of the company,etc.The question above may cause information overlapping problems and may further affect the effectiveness of the stock investment strategy formation.Therefore,how to avoid duplication of information and to achieve the purpose of eliminating this existing problem has become a topic worth exploring.Based on this starting point,this paper uses principal component analysis(PCA)to extract new principal component variables from a series of stock characteristic variables.These new variables are mutually orthogonal and irrelevant.Combined with Fama-Macbeth regression approach(1993),Jegadeesh and Titman portfolio formation approach(1993),this paper further measures the effect of the expected return on stocks under the principal component analysis.The result shows that the momentum investment strategy formed by the principal component analysis performs very well and yields the best stock returns under the weighted market capitalization calculation method.This research has important theoretical and practical significance for investors to make full use of the information available in the stock market and to effectively create investment strategies,and to master the laws of the securities market as well.