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Title: A real option approach to analysing the properties of stock returns : UK evidence
Author: Al-Horani, Ala'a Mohammad Mufleh
ISNI:       0000 0001 3406 2443
Awarding Body: University of Manchester
Current Institution: University of Manchester
Date of Award: 2001
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The relationship between stock returns and non-beta variables has attracted a considerable amount 0 f attention in the US stock market. Existing empirical work suggests that the cross-section of stock market returns can best be explained by the size of a firm and its book-to-market ratio. In explaining the time-series behaviour of stock market returns. size. the book-to-market ratio and a market factor seem to be significant explanatory variables. There is little theoretical justification to support the role of size and book-to-market as determinants of expected stock market returns. Pope and Stark (2000) model the firm as a portfolio of real (production and investment) options and then observe that size and book-to-market capture characteristics of the determinants of the expected returns on such real options. Within these models. size and book-to-market emerge as natural determinants of expected returns because of this feature. This thesis applies the intuition of Pope and Stark (2000) to a study of stock return variability in the UK for the period 1990 to 1996. Using a sample of all listed non financial companies, the analysis examines the relationship between monthly stock returns and the earnings-to-price ratio (E/P), size (ME), book-to-market ratio (BE/ME)market and book leverage (A/ME, A/BE), dividend yield (D/P), cash flow from operations-to-price (CFO/P), research and development-to-price (RD/ME), capacity utilisation (sales-to-total assets (S/A)) and three measures of risk (conventional market beta, unsystematic risk and total risk). Research and development is used for two reasons. First it is anticipated that research and development purchases real investment options and, second, research and development is expensed in the UK, and hence dropped from the book value of equity even though it appears to buy intangible assets. As a result, one explanation of the book-to-market effect is that it, at least in part. captures the impact of intangible assets purchased by expenditure on research and development activities. Using portfolio techniques and Fama and MacBeth (1973) cross-section regression models. the findings reveal in particular, a significant relationship between BE/ML CFO/P and RD/ME and expected returns. Time-series regression results show that the three-factor model of Fama and French (1993) explains returns on a wide range of portfolios but that a fourth factor capturing the effect of RD enhances this three-factor model. Other factors can also play a part in addition to the three factors of Fama and French (1993).
Supervisor: Not available Sponsor: Not available
Qualification Name: Thesis (Ph.D.) Qualification Level: Doctoral
EThOS ID:  DOI: Not available