Download This PaperThe Fundamental-to-Market Ratio and the Value Premium Decline
65 Pages Posted: 13 Apr 2020 Last revised: 18 Aug 2021
Date Written: May 7, 2021
Abstract
Recent evidence indicates the value premium declined over time. In this paper, we argue this decline happened because book equity, BE, is no longer a good proxy for fundamental equity, FE, defined as the equity value originating purely from cash flows. Specifically, we estimate FE for public US firms (from 1973 to 2018) and find that the premium associated with the fundamental-to-market ratio, FE/ME, subsumes the BE/ME premium and has been stable while the cross-sectional correlation between FE/ME and BE/ME decreased over time, inducing an apparent decline in the value premium. We also show that FE/ME provides a better value premium signal than several alternative valuation ratios beyond BE/ME.
Keywords: Value Premium, Book-to-Market, Valuation Ratios, The Cross Section of Expected Returns
JEL Classification: C58, E44, G10, G11, G12
Suggested Citation: Suggested Citation
Andrei S. Gonçalves (Contact Author)
Ohio State University (OSU) - Fisher College of Business ( email )
2100 Neil Avenue
Columbus, OH 43210-1144
United States