Accounting Data, Market Values, and the Cross Section of Expected Returns Worldwide
60 Pages Posted: 2 Jun 2015 Last revised: 19 Jan 2016
Date Written: January 15, 2016
Under fairly general assumptions, expected stock returns are a linear combination of two accounting fundamentals ― book to market and ROE. Empirical estimates based on this relation predict the cross section of out-of-sample returns in 26 of 29 international equity markets, with a highly significant average slope coefficient of 1.05. In sharp contrast, standard factor-model-based proxies fail to exhibit predictive power internationally. We show analytically and empirically that the importance of ROE in forecasting returns depends on the quality of accounting information. Overall, a tractable accounting-based valuation model provides a unifying framework for obtaining reliable proxies of expected returns worldwide.
Keywords: Expected returns, discount rates, fundamental valuation, present value, information quality, international equity markets
JEL Classification: D83, G12, G14, M41
Suggested Citation: Suggested Citation