Understanding the Aggregate Book-to-Market Ratio

55 Pages Posted: 1 May 1999

See all articles by Tuomo Vuolteenaho

Tuomo Vuolteenaho

Arrowstreet Capital, LP; National Bureau of Economic Research (NBER)

Date Written: April 1999

Abstract

In order to connect the stock market valuation level to medium-term cash-flow fundamentals, I develop a dynamic model that links the book-to-market ratio to subsequent profitability, interest rates, and excess stock returns. My approach avoids modeling the potentially unstable dividend process. Consistent with previous research, I find that fluctuating stock market valuations are primarily driven by variation in risk premia. However, interest rate and profitability expectations also play a role in determining market prices. The model generates return and profitability forecasts. Using 1997 data, the model predicts high profitability and low, but not implausible, stock returns over the next decade.

JEL Classification: E44, G10, G12, G14, G35

Suggested Citation

Vuolteenaho, Tuomo, Understanding the Aggregate Book-to-Market Ratio (April 1999). Available at SSRN: https://ssrn.com/abstract=161911 or http://dx.doi.org/10.2139/ssrn.161911

Tuomo Vuolteenaho (Contact Author)

Arrowstreet Capital, LP ( email )

44 Brattle St., 5th Floor
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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