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

45 Pages Posted: 19 Dec 2016 Last revised: 24 Nov 2017

Paolo Giordani

Sveriges Riksbank - Research Division

Michael Halling

Stockholm School of Economics & Swedish House of Finance

Date Written: November 23, 2017

Abstract

While a large literature on return predictability has shown a link between valuation levels and expected rates of returns, we document a link between valuation levels and the shape of the distribution of cumulative (for example, over 12 and 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. Analyzing the US market as of September 2017, our empirical methodology predicts very negatively-skewed distributions with substantial crash risk and low expected rates of returns.

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 (November 23, 2017). 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)

Stockholm School of Economics & Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

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