The Fundamental-to-Market Ratio and the Value Premium Decline

40 Pages Posted: 13 Apr 2020

See all articles by Andrei Gonçalves

Andrei Gonçalves

University of North Carolina (UNC) at Chapel Hill - Finance Area

Gregory Leonard

University of North Carolina at Chapel Hill

Date Written: April 11, 2020

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 expected cash flows (i.e., no discount rate differences across firms). 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, has been large and stable while the cross-sectional correlation between FE/ME and BE/ME decreased over time, inducing an apparent decline in the value premium. Our results echo recent findings in the corporate finance literature.

Keywords: Value Premium, Book-to-Market, Valuation Ratios, The Cross Section of Expected Returns

JEL Classification: C58, E44, G10, G11, G12

Suggested Citation

Gonçalves, Andrei and Laonard, Gregory, The Fundamental-to-Market Ratio and the Value Premium Decline (April 11, 2020). Kenan Institute of Private Enterprise Research Paper , Available at SSRN: https://ssrn.com/abstract=3573444 or http://dx.doi.org/10.2139/ssrn.3573444

Andrei Gonçalves (Contact Author)

University of North Carolina (UNC) at Chapel Hill - Finance Area ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

Gregory Laonard

University of North Carolina at Chapel Hill ( email )

Chapel Hill, NC
United States

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