Abstract:
This study investigates the performance of common stock returns with respect to two
popularly known firm level characteristics: size and book-to-market ratio of selected
companies to explain the cross-sectional variation in expected returns in the stock market
of Sri Lanka. The selected companies are grouped into two categories on the basis of
financial classification of Sri Lankan emerging markets: financial companies and non
financial companies. The sample of the study covers a six-year period from 2005 to 2010.
The formal tests use the Fama-MacBeth (1973) cross-sectional regression model. In the
formal tests, returns are regressed on size and book-to-market-equity both individually
and jointly, in every year in the cross-section.
The results show that, no size effect in all the markets and a significant book-to-market
effect in all the groups. When the test allow for both variables, the positive relationship
between size and stock return is not significant and negative relationship between book to-
market equity and stock return is significant. The inclusion of book-to-market equity
seems to absorb the role of size in selected Sri Lankan stock returns.
Although small firms have to a certain extent higher average return than large firms in
selected Sri Lankan markets, the book-to-market variables seems to have a consistently
stronger role in average returns. The negative value effect found in this study has
practical implications for investor in the Sri Lankan stock market
