Question

Google is a big stock and LinkedIN is a small stock, but at the same time Google has a higher book-to-market ratio than LindedIN. According to the size effect, Google should have lower return than LinkedIN because its size is bigger; but according to the value effect, Google should have higher return than LinkedIN because its book to market ratio is higher. Is the above statement correct? Why?

Answer 1

The above statement is correct, below is my possible explation:

Think of the Fama-French model, we have E(R_it) = a + b_1 MKT_t + b_2 Size_t + b_3 BM_t + e_it. b_1-b_3 are the betas with respect to your factors. Small stocks has a higher b_2 (more exposure to the size factor), whereas a value stock has a higher b_3 (more exposure to the value factor). By considering both effects jointly, along with exposure to the market factor, we can determine which stock should have a higher expected return.