Exploration Risk in Oil & Gas Shareholder Returns

Previous research clearly suggests that the explanation of excess asset returns is not fully captured by excess return on the market portfolio and the CAPM beta, as implied by Fama-French (1993) three-factor model. Among the large number of studies following in the footsteps of Fama and French, very few studies include industry-specific variables to explain excess asset returns. Using monthly financial data for 117 oil and gas companies from 1992 to 2006, we supplement the Fama French approach with an industry-specific fundamental factor to capture company exposure to oil and gas exploration risk. Our results indicate that exploration risk contributes significantly to the explanation of oil company excess returns over the period.