The Fundamental-to-Market Ratio and the Value Premium Decline
40 Pages Posted: 13 Apr 2020
Date Written: April 11, 2020
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: Suggested Citation