Reports of beta's death are premature: Evidence from the UK

A number of authors have found that firm size and book-to-market-value capture the cross-sectional variation in average stock returns. More importantly, these variables have been shown to out-perform the CAPM's beta coefficient in explaining the cross-section of US stock returns. However, these studies all employ variants of the two-step estimator due to Fama and MacBeth (Fama, E.F., MacBeth, J.D,, 1973. Risk, return and equilibrium: Empirical tests. Journal of Political Economy 71, 607-636), which impose implicitly the restriction that idiosyncratic returns are uncorrelated. In this paper we use a one-step estimator due to McElroy et al. (McElroy, M.B,, Burmeister, E,, Wall, K.D., 1985, Two estimators for the APT model when factors are measured. Economics Letters 19, 271-275) and find a highly significant role for beta risk in the UK stock market when we allow for correlation amongst idiosyncratic returns. (C) 1998 Published by Elsevier Science B.V. All rights reserved.