Application of Fama Macbeth Two-Step Regression Method in Estimating Financial Risk Premium

This article applies the Fama-MacBeth two-step regression technique to investigate the effect of excess cash holdings on stock returns. By integrating both theoretical and empirical methods, the study explores how excess cash impacts stock valuations. Analyzing financial data from non-financial firms listed on the Shanghai and Shenzhen A-share markets between 2011 and 2020, the research estimates the influence of excess cash holdings. It creates a long-short investment portfolio based on excess cash holdings using monthly trading data from A-shares spanning July 2012 to June 2022. Evaluations using the Fama-MacBeth three-factor, five-factor, and Carhart four-factor framework reveal that companies possessing elevated levels of surplus cash tend to experience notably greater monthly equity returns than their counterparts with limited excess liquidity. This result holds true across various models. Additionally, the study shows a significant positive correlation between excess cash holdings and stock returns, affirming that excess cash can reliably predict future stock performance. Market conditions, the quality of information disclosure, financing constraints, and ownership type also significantly influence this relationship. Both state-owned and private companies with higher excess cash holdings tend to outperform those with lower cash reserves. This study enhances our understanding of the determinants of stock returns and confirms the positive correlation between excess cash holdings and anticipated returns in the Chinese stock market.