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Using Common Equity for Book-to-Market Ratios in Return Research

Article Quant Q&A · Author: Julien Maas
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Summary

The document addresses which book equity measure to use when replicating a monthly book-to-market variable in a study of expected stock returns. The accepted response infers that the intended numerator is common equity, even though the paper does not explicitly state the choice. Its reasoning is that the cited Fama–French study defines book-to-market using book value of common equity divided by market equity, and the paper under replication uses shares outstanding data associated with common stocks.

The response also notes a reference to another study using common equity per share, which supports the same interpretation. This is an evidence-based inference from related definitions and the paper's stock universe, not confirmation from the original author's explicit methodology. The document does not discuss data cleaning, accounting-field mapping, or treatment of share classes and special cases, so those details would still need to be resolved when building a replication.

Key ideas

  • The response infers that common equity is the appropriate book value numerator for the monthly book-to-market ratio.
  • The cited Fama–French definition uses book value of common equity relative to market equity.
  • The paper's focus on common stocks and use of shares outstanding data support that interpretation.
  • The source paper does not explicitly confirm the measure, so the recommendation remains an inference.
  • The document does not resolve accounting-field and share-class data details.

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EquitiesFactor investingStatistics
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# Answer by Julien Maas (score 2, accepted)


# Should I use common equity or total equity for book value? (when replicating Lewellen's 2015 paper on a cross section of expected stock returns)












I'd hereby would like to ask if any of you know whether I should use common equity or the total equity value, when computing monthly BM ratio's as done by Lewellen is his 2015 paper on a cross section of expected stock returns.

Full reference; Lewellen, J. (2015). The cross-section of expected stock returns. Critical Finance Review, 4(1), 1–44. https://doi.org/10.1561/104.00000024

Accessible at; https://faculty.tuck.dartmouth.edu/images/uploads/faculty/jonathan-lewellen/ExpectedStockReturns.pdf

I believe he is only looking at common stocks, yet at the same time to calculate the market value of equity I can only find the shares outstanding of all public shares on a monthly basis in CRSP.

Thank you in advance,

Kind regards, Julien Maas

## Answer by Julien Maas (score 2, accepted)

https://quant.stackexchange.com/a/77361

Even though he does not state it explicitly, it is likely that he used the value of common equity as the book value of equity.

On page 12, Lewellen states "some studies follow Fama and French (1992) and calculate B/M once a year" and then he says that his measure is computed at the beginning of each month.

If we look at Fama and French 1992, which has the same name as Lewellen's paper, on page 428, they mention that BE/ME is the ratio of the book value of common equity to its market value. And they define Market equity as (a stock price times shares outstanding) on page 427.

Since he uses the shares outstanding from CRSP, and is only looking at common stocks. It makes sense that this would be his definition as well.

Moreover he refers to another study (Rosenberg et al, 1985) that used common equity per share as the book value of equity.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.