Has The Cross-Section of Average Returns Always Been the Same? Evidence from Germany, 1881-1913

The cross-section of average annual returns on German common stock in the period of 1881-1913 exhibits several of the patterns that have been observed in more recent U.S. data. Market beta is hardly important, and its explanatory power is swamped by size and the ratio of book value to market value. A book-to-market risk measure (covariance with a portfolio long in high book-to-market firms and short in low book-to-market firms) has no effect on the explanatory power of the book-to-market characteristic. But the size effect appears to be caused by selection bias in the sample. And the book-to-market effect is opposite that of the recent U.S. experience (and, hence, can certainly not be attributed to selection bias). Finally, a momentum portfolio constructed on the basis of the error of the basic 3-characteristic model (market beta, size and book-to-market) does not generate significant returns. These findings highlight the variability in the power of certain characteristics in explaining the cross section of average returns.