Impact of Macroeconomic Variables on Size and Book to Market Effects in Stock Returns: Evidence from Sri Lanka

Abstract

The main purpose of this study is to find out whether size and BM effects are subsumed by macroeconomic variables in explaining variation in stock returns in Sri Lanka using stocks listed in the CSE. The sample covers the listed stocks from 1998 to 2013 that have information on share price, market capitalization and book value of equity. The macroeconomic variables considered for the study consist of change in expected inflation, unanticipated inflation, unanticipated change in term structure, unanticipated change in risk premium and growth rate in industrial production. Nine Size-BM portfolios are constructed each year for the purpose of analysis and Fama-MacBeth cross sectional regressions designed for various models over four holding periods ranging from one month to one year constitute the main test method. The results indicate that apart from semiannual holding period macroeconomic variables subsume size and BM effects in explaining variation in stock returns.