NORTH - H(XlAND

An Examination of the Cross-Sectional Relationship of Beta and Return: UK Evidence

Jonathan Fletcher

This paper examines the conditional relationship between beta and return in UK stock returns. There is no evidence of a significant risk premium on beta when the unconditional relationship between beta and return is considered. When the sample is split into periods according to whether the excess market return is positive or negative, there is a significant relationship between beta and return. However, the relationship is stronger in months when the excess market return is negative than when it is positive. Subsidiary results of the paper also indicate the absence of the size effect in UK stock returns. 1997 Temple University

Keywords: CAPM; Beta; Conditional relationship JEL classification: G12

I. Introduction
The Capital Asset Pricing Model (CAPM) developed by Sharpe (1964), Lintner (1965) and Mossin (1966) has been one of the premier models 1 in finance. It has been widely used in cost of capital estimation and the performance measurement of managed funds. There has been renewed interest in the CAPM following the recent study of Fama and French (1992). Fama and French found that, using nearly 50 years of US stock return data, there was a fiat relationship between return and

Department of Finance and Accounting, Glasgow Caledonian University, Glasgow, United Kingdom (JF). Address correspondence to: Dr. Jonathan Fletcher, Department of Finance and Accounting, Glasgow Caledonian University, Cowcaddens Road, Glasgow, G4 0BA, UK. 1 Other popular models of risk and return include the Arbitrage Pricing Theory [Ross (1976)], the multi-beta CAPM [Merton (1973)] and the consumption CAPM [Breeden (1979)].

Journal of Economics and Business 1997; 49:211 221 1997 Temple University

0148-6195/97/$17.00 PII S0148-6195(97XI0006-4

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J. Fletcher beta. This was widely reported in the financial press as the death knell of beta. 2 Similar findings of an insignificant relationship between beta and return have been observed in UK stock returns by Strong and Xu (1994) for the period 1973-1992. Recent studies have tended to counter the findings of Fama and French (1992). Chan and Lakonishok (1993), Jagannathan and Wang (1996), Kothari et al. (1995a) and Kim (1995) suggested some support of a positive relationship between return and beta. The differences seem to be due to the time period examined [Chan and Lakonishok (1993)], return interval over which beta is estimated [Kothari et al. (1995a)], 3 the form in which the CAPM is tested [Jagannathan and Wang (1996)] and statistical issues [Kim (1995)]. An alternative explanation of the fiat relationship between return and beta was proposed by Pettengill et al. (1995). They argued that the statistical methodology used to evaluate the relationship between beta and return requires adjustment to take account of the fact that realized returns and not ex ante returns have been used in the tests. They developed a conditional relationship between return and beta which depends on whether the excess return on the market index is positive or negative. In periods when the excess market return is positive (up market), there should be a positive relationship between beta and return. In periods when the excess market return is negative (down market), there should be a negative relationship between beta and return. This is because high beta stocks are more sensitive to the negative market excess return and will have a lower return than low beta stocks. The evidence in Pettengill et al. (1995) shows that for the period 1936-1990, there is strong support for beta when the sample period is split into up market and down market months. This paper examines the cross-sectional relationship between beta and return in UK stock returns between January 1975 and December 1994. The main objective of the paper is to examine the conditional relationship between beta and return proposed by Pettengill et al. (1995) to UK stock returns. The paper also considers the role of size in UK stock returns. Consistent with Strong and Xu (1994) and Fama and French (1992), there is no evidence of a significant risk premium on beta when the unconditional relationship between beta and return is examined. However in periods when the market return exceeds the risk-free return, there is a significant positive relationship between beta and return. When the market return is less than the risk-free return, there is a significant negative relationship between beta and return. The surprising finding of this study is that the relationship is stronger in down market months than up market months. Subsidiary results of the paper provide little support for the size effect in UK stock returns for this time period. This appears to be due to a possible nonlinear relationship between portfolio average return and the proxy for portfolio size. The paper is outlined as follows. Section II contains the regression methodology used in the tests. Section III reports the data and portfolio grouping strategy. Section IV includes the main empirical results. The final section contains concluding comments.

2 See, for example,Peltz (1992). 3See, also, the subsequent papers by Fama and French"(1996)and Kothariet al. (1995b).

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213

II. Methodology
The zero-beta CAPM of Black (1972) predicts that:

E(Ri)

3'0 + 3'1/9/ for all i = 1 . . . . . N

(1)

where E ( R ) is the expected return on asset i; /3i is the beta of asset i where ~i = cv(Ri, Rm)/var(Rm); To is the expected return on the portfolio, which has a zero covariance with the market portfolio4; 71 is the expected risk premium of the market portfolio. Most studies have adopted a two-pass regression methodology to examine whether there is a significant positive risk premium on beta. The two-pass methodology stems mainly from Fama and MacBeth (1973). Shanken (1992) presented a useful review of the statistical framework of the two-pass methodology and some of the econometric issues involved, including the role of size. 5 In the first step, /3~ is estimated from the regression model: Rit = ~i + ~iRmt + c'it

(2)

where Rit is the return on asset i in period t; Rmt is the return on the market proxy portfolio in period t; c-it is a random error term; /3i is the estimated beta of asset i. It is assumed that the error terms in equation (2) are independently and identically distributed with mean zero and stationary covariance matrix, and R,~ t is drawn from a stationary distribution. In the second stage, a cross-sectional regression equation is estimated each month as: Rit = Tot -k- Tit ~i q- uit

(3)

where /3i is estimated from equation (2), and uit is a random error term. Equation (3) is estimated by Ordinary Least Squares (OLS), 6 which gives estimates 3'0t and ~/1~ for each month in the sample period. The average values of the monthly coefficients (70, 71) are calculated, and the average value can be tested to see if it is significantly different from zero using the t test of Fama and MacBeth (1973). 7 The t test can be modified to take account of the effect of measurement error in beta, as an estimate of beta is used in equation (3) [see Shanken (1992)]. Equation (3) can also be extended to include additional variables such as size. The size effect can be examined by testing whether the average value of the monthly coefficients on the size variable is significantly different from zero.

4 When a risk-free asset exists, 2'0 will be the risk-free return, and this is the traditional form of the CAPM of Sharpe (1964). 5 Banz (1981) found that the market value of the firm was inversely related to return after the role of beta had been adjusted for. Berk (1995) has pointed out that a market value variable is a useful specification test of an asset pricing model. 6 Shanken (1992) has pointed out that equation (3) can also be estimated by Generalized Least Squares (GLS) and Weighted Least Squares (WLS). 7 This is simply the average value of the coefficients divided by the standard error of the coefficients. The standard error of the coefficients equals the standard deviation of the monthly coefficients divided by the square root of the number of observations.

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J. Fletcher

The main objective of this study is to examine the conditional relationship between beta and return. Pettengill et al. (1995) argued that studies focusing on the relationship between return and beta need to take account of the fact that ex post returns have been used in the tests and not ex ante returns. When realized returns are used, a conditional relationship between beta and return should exist. This occurs as there must be some probability where investors expect that the realized return on a low beta portfolio will be greater than the return on a high beta portfolio. This is because no investor would hold the low beta portfolio if this were not the case. Pettengill et al. (1995) assumed that this occurs when the market return is lower than the risk-free return, which they suggested is implied by the excess returns market model. The implication of this is that there should be a positive relationship between beta and return when the excess market return is positive, and a negative relationship when the excess market return is negative. To test the conditional relationship, the sample period was divided into up market months and down market months. This is equivalent to splitting the time-series coefficients, 3'1t, into two subsamples. For all the months when the market return exceeded the risk-free return, the corresponding 3'1t were grouped into that subsample. For the months when the market return was less than the risk-free return, the corresponding 3'1, was put into that subsample. ~'2t is defined as the monthly risk premium estimates in up market months and ~3t as the risk premium estimates in down market months. The hypotheses, predicted by PettengiU et al., (1995) are: Ho:72 = 0

Ha: 72 > O
(4) Ho: 73 = 0

Ha'73 *(0
where 72 and 73 are the average values of the coefficients ~2t and 3'3t. These can be tested by the standard t tests of Fama and MacBeth (1973). Pettengill et al. (1995) pointed out that the above conditional relationship does not guarantee a positive risk and return tradeoff. They stated that two conditions are necessary for a positive tradeoff between risk and return. These are that the excess market return should be positive on average and the risk premium in up markets and down markets should be symmetrical. The symmetrical relationship can be tested by the following hypothesis: H0:72 - 73 = 0. (5)

This can be tested by a two-population t test, but the sign of the "Y3t coefficients needs to be reversed and the average value recalculated.

III. Data
Returns were collected for securities included in the London Business School Share Price Database (LBS) between January 1975 and December 1994. The results over two ten-year sub-periods were also considered. We began the sample period here because it is only since 1975 that the LBS has included return data on

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215

all securities which have traded on the London Stock Exchange and Unlisted Securities Market. The monthly return on a 30-day UK Treasury Bill was used as the risk-free return obtained from LBS. The regression approach described in the previous section used portfolios of securities formed from the LBS. Securities were grouped into 100 size-beta portfolios following Fama and French (1992). Securities were included in the portfolios each year if they existed for at least three years prior to the start of that year and were in existence at the start of the year. Beginning with January 1975, all securities with non-zero market values were ranked on the basis of market value (as recorded on LBS) and grouped into 10 portfolios in ascending order. Within each size decile, the beta of the security was estimated from the regression of the security return on a constant and the return on the Financial Times All Share Index (FFA) 8 as the market proxy using past return data over the previous 36 to 60 months. This can be viewed as the pre-ranking beta estimate. The securities within each size decile were then grouped into 10 beta portfolios on the basis of their pre-ranking betas. Equally-weighted returns were calculated each month on the 100 portfolios over the subsequent year. This procedure was repeated for each year and gave 240 monthly return observations between January 1975 and December 1994, for each portfolio. The number of securities included in each portfolio varied from year to year. For 1975 to 1977, the number of securities within each portfolio was between 13 to 14, and for the later years ranged between 17 to 19, on average. Table 1 presents the average monthly return of the 100 size-beta portfolios. There is quite a wide dispersion in the monthly average returns of the 100 size-beta portfolios, which ranged between 0.33% to 2.22%. Each of the 10 portfolios in the smallest market value decile had a higher average return than the corresponding portfolios in the largest market value decile. There does not appear to be a strong relationship between average return and beta within a given size decile. In a majority of the size deciles, the low beta portfolio had a higher mean return than the high beta portfolio. Also, the relationship between average return and size portfolios within a given beta decile is not monotonic. The average returns tend to

8 This is a value-weighted index of the largest 750 companies on the London Stock Exchange.

Table 1. Average Return of 100 Size-Beta Portfolios a

MV 1 MV 2 MV 3 MV4 MV5 MV6 MV 7 MV 8 MV 9 MV10 1.95 1.4 1.39 1.31 0.91 1.61 1.14 1.42 1.24 1.27 1.83 1.41 1.47 1.15 1.04 1.33 1.36 1.14 1.37 1.59 1.79 1.26 1.49 1.38 1.44 1.39 1.29 1.44 1.53 1.32 1.66 1.68 1.61 1.38 1.38 1.35 1.49 1.32 1.56 1.55 1.87 1.65 1.69 1.72 1.1 1.46 1.21 1.62 1.42 1.24 2.14 1.65 1.27 1.55 1.49 1.39 1.15 1.47 1.42 1.48 1.45 1.48 1.01 1.25 0.73 1.51 1.4 1.38 1.57 1.25 2.06 1.22 1.17 0.82 1.2 1.12 1.6 1.45 1.44 1.77 2.22 1.44 1.54 1.6 1.0l 1.0 1.23 1.6 1.54 1.56 1.65 0.33 0.38 1.05 1.21 0.87 0.88 0.78 1.11 1.28

a The table reports the monthly average return (%) of 100 size-beta portfolios for the period January 1975 to December 1994. The individual securities are first grouped into 10 size (rows) deciles for each year, and then within each decile they are further grouped into 10 beta portfolios (columns).

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J. F l e t c h e r

Table 2. Portfolio Beta of 100 Size-Beta Portfolios a 31

MV 1 MV 2 MV 3 MV4 MV5 MV6 MV 7 MV 8 MV 9 MVI0 0.59 0.64 0.64 0.69 0.71 0.68 0.74 0.82 0.87 0.88

3z
0.63 0.78 0.75 0.74 0.91 0.91 0.91 0.98 1.03 0,98

33
0.78 0.74 0.79 0.82 0.88 0.95 1.01 1.07 1.08 0.92

34
0.72 0.95 0.92 0.91 1.03 1.01 0.99 1.07 1.1 0.99

35
0.92 0.9 0.98 1.02 1.01 1.05 1.02 1.1 1.21 1.08

136
1.04 1.04 1.00 1.04 1.11 1.12 1.13 1.08 1.12 1.12

37
1.02 1.08 1.05 1.07 1.12 1.11 1.18 1.24 1.19 1.11

/38
1.19 1.15 1.08 1.14 1.22 1.21 1.09 1.21 1.26 1.13

39
1.23 1.17 1.36 1.29 1.25 1.26 1.3 1.32 1.27 1.16

310
1.37 1.34 1.22 1.47 1.42 1.45 1.46 1.45 1.36 1.25

a The table reports were the portfolio beta of 100 size-beta portfolios for the period January 1975 to December 1994. The portfolio betas were computed relative to the equally-weighted index (EWl) as the market proxy. The individual securities are first grouped into 10 size (rows) deciles for each year, and then within each decile they are further grouped into 10 beta portfolios (columns).

decline and then rise again as we move down the columns in Table 1 in a number of cases. Table 2 reports the post-ranking beta estimates of the 100 size-beta portfolios. The betas were estimated from the regression of the portfolio returns on a constant and the returns of the market proxy between January 1975 and December 1994. The F T A and an equally-weighted index (EWI) were used as the market proxies. 9 The EWI proxy is an equally-weighted portfolio of all securities with return observations from LBS in a given month. Only the betas estimated using the EWI proxy are reported in Table 2. Table 2 shows that there is a close relationship between the post-ranking betas and the pre-ranking betas. Table 3 gives the log of the time-series average of the market values of the 100 size-beta portfolios between January 1975 and December 1994. The size of the

9 The results of this study should not be viewed as strict tests of the CAPM because of Roll's (1977) critique about the unobservability of the market portfolio. Given this, the results of this paper can be viewed as tests of a single factor model in U K stock returns.

Table 3. Average Market Value (Log) of 100 Size-Beta Portfoliosa

fll
MV 1 MV 2 MV 3 MV4 MV5 MV6 MV 7 MV s MV 9 MV10 0.39 1.07 1.62 2.08 2.51 2.99 3.52 4.15 5.06 7.26

32
0.36 1.08 1.62 2.08 2.51 2.98 3.52 4.17 5.08 7.45

33
0.42 1.08 1.62 2.09 2.53 2.99 3.54 4.18 5.09 7.33

34
0.39 1.13 1.64 2.11 2.52 3.02 3.54 4.19 5.08 7.10

35
0.44 1.11 1.66 2.10 2.51 3.01 3.57 4.2 5.09 7.07

36
0.44 1.12 1.62 2.09 2.53 3.01 3.54 4.22 5.16 7.02

37
0.47 1.11 1.64 2.11 2.54 3.03 3.56 4.24 5.16 7.10

38
0.43 1.12 1.66 2.11 2.54 3.01 3.55 4.24 5.21 7.09

39
0.42 1.12 1.64 2.10 2.54 3.01 3.56 4.23 5.15 7.02

310
0.44 1.11 1.65 2.11 2.53 3.00 3.54 4.20 5.14 6.81

'~The table reports the log of the time-series average market value of 100 size-beta portfolios for the period January 1975 to December 1994. The size of the portfolios was calculated for each year as the average market value of the start of the year of the securities in the portfolio. The individual securities are first grouped into 10 size (rows) deciles for each year, and then within each decile they are further grouped into 10 beta portfolios (columns).

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portfolios was calculated for each year as the average market value at the beginning of the year (obtained from LBS) of the securities in the portfolio. The values ranged between 0.36 to 7.45 (in million pounds).

IV. The Role of Beta and Size in Returns

Initially the relationship between portfolio beta and size and the monthly returns of the 100 size-beta portfolios was examined without distinction between up markets and down markets. The betas of the portfolios were estimated for the full period between January 1975 and December 1994, with respect to the FTA and EWI proxies. Table 4 presents the results of the monthly cross-sectional regressions of portfolio returns, beta and size. The coefficients were estimated by OLS, and the t statistics of Fama and MacBeth (1973) have been corrected for the measurement error in beta as suggested by Shanken (1992). Panel A refers to the FTA proxy and panel B to the EWI proxy. The evidence in Table 4 suggests that there is no significant positive risk premium on beta in U K stock returns. Indeed, the estimated risk premium on beta is actually negative, although insignificant, which suggests a downward sloping relationship between beta and return. On an annualized basis, the estimated risk premium on beta is - 3 . 7 6 % (FTA) and - 4 . 8 2 % (EWI). When the analysis was repeated over two ten-year subperiods (January 1975-December 1984 and January 1985-December 1994), the estimated risk premiums on beta were 0.00049 (t = 0.073) and - 0.00762 (t = - 1.22) for the FTA proxy, and 0.00143 (t = 0.254) and -0.0115 (t = - 1.94) for the EWI proxy. Again, there is no support of a significant positive risk premium over either sub-period. The findings of an insignificant risk

Table 4. Cross-Sectional Regressions of Portfolio Returns on Beta and Sizea

Panel Ab Intercept-T0 0.0162 5.25" 0.0163 6.35" Panel B c Intercept-% 0.01799 6.97" 0.0181 6.46* Beta-~ i - 0.00402 - 0.94 - 0.0038 - 0.94 Size-5'2 Beta-~,l - 0.00313 - 0.66 - 0.0035 - 0.703 Size-~'2

Coefficient t Coefficient t

0.000068 0.13

Coefficient t Coefficient t

- 0.000099 - 0.21

* Significant at 5%. a Monthly cross-sectional regressions were run on portfolio returns of the 100 size-beta portfolios on a constant and the estimated beta for the period J a n u a r y 1975 to D e c e m b e r 1994. T h e regressions were also estimated including a proxy for portfolio size. The coefficients Y0, ~1 and 5'2 are the time-series averages of %t, ~/lt and ~/2t estimated using Ordinary Least Squares (OLS). The t statistics have been corrected for the m e a s u r e m e n t errors in beta, as suggested by Shanken (1992), and test w h e t h e r the estimated coefficient is significantly different from zero. b Panel A of the table uses portfolio betas estimated from the Financial Times All Share index (FTA). c Panel B uses the equally-weighted index ( E W I ) to estimate betas.

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J. Fletcher premium on beta 1 is consistent with Fama and French (1992) and Jagannathan and Wang (1996) for US market proxies, and also with Strong and Xu (1994) in UK stock returns. This may be due to the low power of these tests [see Affleck-Graves and Bradfield (1993)]. The other interesting observation from Table 4 is the absence of the size effect in UK stock returns, as the coefficient on the size variable is insignificantly different from zero. The coefficient on the size effect continues to be insignificant over the two ten-year sub-periods. This contrasts with most US studies, but is consistent with Strong and Xu (1994), n who found no evidence of a size effect for the period 1973 to 1992. Examination of Table 1 suggests a possible explanation of the insignificant relationship between size and returns. When a proxy for the size variable is included in the regressions, it is assumed that the relationship between size of the portfolios and average return is linear. However Table 1 shows that for many of the pre-ranking beta deciles, the relationship between the size of the portfolios and average return appears U-shaped. Although the average return of the portfolios of the smallest size decile are the highest, there is not a monotonic decline in the average returns as we move across the size portfolios. The absence of this linear size relationship has been checked by adding a squared size variable to the cross-sectional regression. The coefficient on the squared size variable is statistically significant over the whole sample period. This suggests that the absence of the size effect is caused by a possible non-linear relationship between portfolio average return and the proxy for portfolio size. A number of explanations have been put forward for the findings of an insignificant relationship between beta and return. The one which is considered in this study is that proposed by Pettengill et al. (1995), who argued that the finding of the fiat slope arises when realized returns are used in the tests. This is because the relationship between beta and return in this situation will be conditional on the excess returns on the market index. The hypotheses of Pettengill et al. (1995) can be evaluated by splitting the monthly risk premium estimates into two subsamples according to whether the excess market return is positive or negative. The hypotheses were tested for the whole sample period and for the two ten-year sub-periods. Table 5 contains the results. Panel A refers to the VIA proxy and panel B to the EWI proxy. The table reports the mean values of ~2t and ~/3t with corresponding t statistics and the number of up market and down market months over the sample period (reported in parentheses). The table also includes t values of the test that 92 - 93 = 0, which tests whether the relationship between beta and return in up market and down market months is symmetrical. Table 5 shows that there are a substantial number of down market months over the sample period, 97 for the VIA proxy and 100 for the EWI proxy. The evidence in Table 5 suggests that in periods of up market months, there is a significant

10 The regressions were also estimated by GLS and WLS as given in Shanken (1992), but this has no impact on the inferences in Table 4. n Strong and Xu (1994) did find a significant book-to-market equity effect as in Fama and French (1992).

Beta and Return:

UK Evidence Relationship Between Beta and Return a

219

Table 5. Tests of the Conditional

Panel Ab All 72 t 73 t 72 - 73 = 0 0.03175(143) 5.89* - 0.05456(97) - 10.34" -3.02* Panel B c All ~2 t 73 t 72 -- ~3 = 0 0.02778(140) 5.84* - 0.04854(100) -- 9.29* -2.94* 1/75-12/84 0.02266(78) 3.38* -- 0.0379(42) - 5.5* -1.59 1/85-12/94 0.0303(62) 5.28* - 0.056(58) - 8.43* -2.95* 1/75-12/84 0.03579(74) 4.67* - 0.05628(46) - 7.48* - 1.98 1/85-12/94 0.0268(69) 4.01" - 0.05419(51) - 7.1" -2.7*

* Significant at 5%. a The m o n t h l y risk p r e m i u m coefficients on beta, "Ylt have b e e n divided into two subsamples a c c o r d i n g to w h e t h e r the excess m a r k e t r e t u r n was positive or negative. T h e coefficients ~2 a n d ~3 are the time-series averages of the risk p r e m i u m estimates in up m a r k e t s (positive excess m a r k e t r e t u r n s ) a n d down m a r k e t s (negative m a r k e t excess returns), respectively. The t statistics [computed using the time-series a p p r o a c h of F a m a a n d M a c B e t h (1973)] are one-sided tests of w h e t h e r ~2 is significantly positive a n d ~3 is significantly negative, respectively. T h e last row is a two p o p u l a t i o n t test of ~2 - ~ 3 = 0. The results are r e p o r t e d for the period J a n u a r y 1975 to D e c e m b e r 1994, a n d over two t e n - y e a r sub-periods. b P a n e l A of the table uses portfolio betas estimated from the Financial Times All Share index (FTA). c Panel B uses the equally-weighted index ( E W l ) to estimate betas.

positive relationship between beta and return. High beta portfolios exhibited higher returns than low beta portfolios. In periods of down-markets, there is a significant negative relationship between beta and return. High beta portfolios earned a lower return than low beta portfolios. Similar patterns are observed over the two sub-periods and with both market proxies. 12 This is consistent with the hypotheses and the evidence given in Pettengill et al. (1995). It is important to take account of the conditional relationship between beta and return in empirical tests. The hypothesis that the relationship between beta and return in up market and down market months is symmetrical, is rejected in Table 5. The estimated risk premiums in down markets are higher than those in up markets. This contradicts one of the necessary conditions of a positive risk-return tradeoff, This is inconsistent with Pettengill et al. (1995), who found that the relationship was symmetrical in US stock returns. It is a puzzle why the relationship between beta and return should be stronger in down markets. The results in Table 5 were checked to examine if the October 1987 crash or the January effect documented by Rozeff and Kinney (1976), amongst others, had any impact on the inferences. The October 1987 observation and the January months were excluded from the analysis. Similar inferences were found in both cases to Table 5. Neither the October 1987 crash or the January effect explain why the relationship between beta and return is stronger in down markets.

~2 S i m i l a r r e s u l t s w e r e f o u n d w h e n b e t a s w e r e e s t i m a t e d u s i n g a n excess r e t u r n s r e g r e s s i o n .

220

J. Fletcher The evidence within the paper does suggest that there is a conditional relationship between beta and return in U K stock returns. It also indicates that beta may still have a useful role to play for portfolio managers. Investors who are concerned about the risk of periods where the market return falls below the risk-free return, could protect themselves by investing in low beta stocks. Beta seems to be a good indicator of how stocks react in periods of down market months. Related evidence is Chan and Lakonishok (1993) and Grundy and Malkiel (1996).

V. Conclusions
This paper has examined the conditional relationship between beta and return in the U K between January 1975 and December 1994. Consistent with the findings of Fama and French (1992) and Strong and Xu (1994), there was no evidence of a significant risk premium on beta when the unconditional relationship between beta and return was examined. Also, there was no significant relationship between size and returns. This appears to be due to a possible non-linear relationship between portfolio average returns and the proxy for portfolio size. When the sample period was split into periods of whether the excess market return was positive or not, there was a significant positive relationship between beta and return in periods of positive excess market returns, and a significant negative relationship between beta and return in periods of negative excess market return. This is consistent with Pettengill et al. (1995), and suggests the need to focus on the conditional relationship between beta and return. However, the conditional relationship between beta and return in up market and down market months was not symmetrical, as predicted by Pettengill et al. (1995). The relationship was stronger in down markets. This contradicts one of the conditions of a positive risk and return tradeoff. The results of the paper do suggest that the market beta still has a role to play for portfolio managers.

Extremely helpful comments were received from K. Paudyal, the editor (J. Affleck-Graves)and two anonymous referees.

References
Affleck-Graves, J. D. and Bradfield, D. J. Feb. 1993. An examination of the power of univariate tests of the CAPM: A simulation approach. Journal of Economics and Business 45(1):17-33. Banz, R. W. Mar. 1981. The relationship between return and market value of common stocks. Journal of Financial Economics 9(1):3-18. Berk, J. Summer 1995. A critique of size related anomalies. Review of Financial Studies 8(2):275-286. Black, F. July 1972. Capital market equilibrium with restricted borrowing. Journal of Business 45(3):444-455. Black, F. Fall 1993. Beta and return. Journal of Portfolio Management 19(1):8-18. Breeden, D. T. Sept. 1979. An intertemporal asset pricing model with stochastic consumption and investment opportunities. Journal of Financial Economics 7(3):265-296.

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