Rim-Based Value Premium and Factor Pricing Using Value-Price Divergence

68 Pages Posted: 20 Feb 2023 Last revised: 12 Apr 2023

See all articles by Lin William Cong

Lin William Cong

Cornell University - Samuel Curtis Johnson Graduate School of Management; National Bureau of Economic Research (NBER)

Nathan George

University of California, Berkeley

Guojun Wang

Shanghai Normal University; Tongji University

Multiple version iconThere are 2 versions of this paper

Date Written: February 2023

Abstract

We document that value-to-price, the ratio of Residual-Income-Model-based valuation to market price, subsumes the power of book-to-market ratio and many other value or quality measures in predicting stock returns. Long-short value-to-price portfolios hedge against momentum, revitalize the seemingly missing value premium over past decades, and generate significant returns after adjusting for common factors. The value-price-divergence (VPD) factor constructed from the average returns of these portfolios within small and big stocks is not spanned by these known factors. Max Sharpe ratio and constrained R-squared tests reveal that VPD is a better substitute for the traditional value factor and a four-factor model using the VPD, market, momentum, and size factors outperforms most extant benchmarks in explaining the cross-section of expected equity returns. The findings remain robust under alternative specifications of equity cost of capital.

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Suggested Citation

Cong, Lin and George, Nathan and Wang, Guojun, Rim-Based Value Premium and Factor Pricing Using Value-Price Divergence (February 2023). NBER Working Paper No. w30967, Available at SSRN: https://ssrn.com/abstract=4364715

Lin Cong (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States

HOME PAGE: http://www.linwilliamcong.com/

National Bureau of Economic Research (NBER) ( email )

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Nathan George

University of California, Berkeley ( email )

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Berkeley, CA 94720
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Guojun Wang

Shanghai Normal University ( email )

No.100 Guilin Road
Shanghai, 200234
China

Tongji University ( email )

School of Economics and Management
1239 Siping Rd
Shanghai
China

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