29 Pages Posted: 24 Nov 2013 Last revised: 30 Aug 2014
Date Written: July 1, 2014
Daniel and Titman (2006) propose that the value premium is due to investors overreacting to in- tangible information. They therefore decompose five-year changes in firms' book-to-market ratios into stock returns and a residual that is a proxy for tangible information based on accounting performance ("book returns"). Consistent with investors overreacting to intangible information, they find that only stock returns orthogonal to book returns reverse. We show that their decomposition creates a book return polluted by past book-to-market ratios, stock returns, net issuances, and dividends. Empirically, two-fifths of the variation in book returns is due to these factors. In addition, the Daniel and Titman (2006) result is sensitive to methodological choices. When we use the change in the book value of equity as a proxy for tangible information, only the tangible component of stock returns reverses. Moreover, current book-to-market subsumes the intangible return's power to predict the cross-section of average returns, which casts doubt on the argument that book-to-market forecasts returns because it is a good proxy for the intangible return.
Suggested Citation: Suggested Citation
Gerakos, Joseph J. and Linnainmaa, Juhani T., Market Reactions to Tangible and Intangible Information Revisited (July 1, 2014). Chicago Booth Research Paper No. 13-82; Fama-Miller Working Paper. Available at SSRN: https://ssrn.com/abstract=2358513 or http://dx.doi.org/10.2139/ssrn.2358513
By Lu Zhang