Up the Stairs, Down the Elevator: Valuation Ratios and Shape Predictability in the Distribution of Stock Returns

36 Pages Posted: 19 Dec 2016 Last revised: 13 Jan 2017

Paolo Giordani

Sveriges Riksbank - Research Division

Michael Halling

Swedish House of Finance

Date Written: December 18, 2016

Abstract

While a large literature on return predictability has shown a link between valuation levels and expected rates of returns, we document a robust link between valuation levels and the shape of the distribution of cumulative (up to 24 months) total returns. Return distributions become more asymmetric and negatively skewed when valuation levels are high. In contrast, they are roughly symmetric when valuation levels are low. These results shed some light on how equity prices regress back to their means conditional on valuation levels and have important practical implications for risk measurement and asset management.

Keywords: return predictability, valuation ratios, skewness

JEL Classification: G12, G17, C22

Suggested Citation

Giordani, Paolo and Halling, Michael, Up the Stairs, Down the Elevator: Valuation Ratios and Shape Predictability in the Distribution of Stock Returns (December 18, 2016). Swedish House of Finance Research Paper No. 17-5. Available at SSRN: https://ssrn.com/abstract=2887156

Paolo Giordani

Sveriges Riksbank - Research Division ( email )

S-103 37 Stockholm
Sweden

HOME PAGE: http://www.riksbank.com/templates/Page.aspx?id=22013

Michael Halling (Contact Author)

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

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