Why does book-to-market value of equity forecast cross-section stock returns? |
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Authors: | George Bulkley Renata Herrerias |
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Institution: | School of Business and Economics, University of Exeter, Exeter EX4 4PU, UK |
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Abstract: | In this paper, we derive a model of book-to-market value of equity based on the present value model and estimate it using panel data on individual stocks. We explicitly include in the model all the determinants of book-to-market except the firm-specific discount rate, which we capture using fixed individual effects in the panel data model. The model is particularly successful, explaining nearly 90% of the time series and cross-section variation in the ratio of book-to-market value of equity. Moreover, the estimated firm-specific fixed effects are more successful than the most recent book-to-market value of equity in forecasting subsequent returns. This is consistent with an efficient market in which book-to-market is a proxy for risk. |
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Keywords: | Book-to-market value of equity Fixed effects panel data model Efficient markets hypothesis |
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