An Evaluation of the Ability of Logit-Based Financial Statement Analysis to Identify Market Mispricing

Posted: 23 Sep 1996

See all articles by Richard M. Morton

Richard M. Morton

Florida State University - Department of Accounting

Philip B. Shane

College of William & Mary

Date Written: Undated

Abstract

Using logit-based financial statement analysis, Ou and Penman estimate an earnings predictor (Pr) that also predicts returns. We develop a forecasting model that purges measurement error (i.e., expected earnings) from the Ou and Penman proxy for the market's unexpected earnings. If market mispricing explains the returns to their trading strategy, then these returns should increase when we estimate Pr to predict our proxy for the market's unexpected earnings. Alternatively, if the market is efficient with respect to this information, then Pr can only predict the market's expected earnings and abnormal returns should decrease when the analysis is aimed at our unexpected earnings proxy which contains less expected earnings. None of our results support the mispricing explanation. The results support the alternative explanation that Pr predicts abnormal returns because it predicts expected earnings which are associated with expected returns omitted from the model used to estimate abnormal returns.

JEL Classification: G14, M41, G12

Suggested Citation

Morton, Richard M. and Shane, Philip B., An Evaluation of the Ability of Logit-Based Financial Statement Analysis to Identify Market Mispricing (Undated). Available at SSRN: https://ssrn.com/abstract=2754

Richard M. Morton

Florida State University - Department of Accounting ( email )

Room No. 421
Tallahassee, FL 32306-8234
United States
850-644-7877 (Phone)

Philip B. Shane (Contact Author)

College of William & Mary ( email )

P.O. Box 8795
Williamsburg, VA 23185
United States

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