CROSS-SECTIONAL RETURN DISPERSION AND TIME VARIATION IN VALUE, SIZE AND MOMENTUM PREMIUMS

Abstract

This thesis discovers that recent return dispersion (RD) measured using a cross-sectional standard deviation of 100 size- and value-sorted portfolios is positively correlated with the subsequent size and value premiums, inconsequential for the momentum premium, and negatively correlated with the market risk premium. The results from in-sample regressions using stock data from Feb. 1968 to Jan. 2011 remain strong even after controlling for other commonly established predictors. My findings lend support to existing theoretical and empirical insights that the size and value premiums are driven by risk, of which idiosyncratic risk and economic uncertainty are reflected uniquely by RD and not captured by other commonly established predictors. In addition, my findings contradict Stivers and Sun’s (2010) proposed RD-momentum connection after controlling for market volatility, a factor which they omitted; debunk DiBartolomeo’s (2003) conjecture of a negative RD-value relationship; and question the positive price in market risk premium for bearing greater idiosyncratic risk. Finally, a parsimonious set of predictors produced by stepwise regression confirms RD’s usefulness in understanding each of the premiums above.