The Price is (Almost) Right

61 Pages Posted: 6 Mar 2005

See all articles by Randolph B. Cohen

Randolph B. Cohen

Harvard Business School - Finance Unit

Christopher Polk

London School of Economics

Tuomo Vuolteenaho

Arrowstreet Capital, LP; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: November 17, 2003

Abstract

Most previous research tests market efficiency and asset pricing models using average abnormal trading profits on dynamic trading strategies, and typically rejects the joint hypothesis. In contrast, we measure the ability of a simple risk model and the efficient-market hypothesis to explain the level of stock prices. First, we find that cash-flow betas (measured by regressing firms' earnings on the market's earnings) explain the prices of value and growth stocks well, with a plausible premium. Second, we use a present-value model to decompose the cross-sectional variance of firms' price-to-book ratios into two components due to riskadjusted fundamental value and mispricing. When we allow the discount rates to vary with cash-flow betas, the variance share of mispricing is negligible.

Keywords: stock prices, present value, book-to-market, variance decomposition, capital asset pricing model, beta, expected returns, return on equity

JEL Classification: G120, G140

Suggested Citation

Cohen, Randolph B. and Polk, Christopher and Vuolteenaho, Tuomo, The Price is (Almost) Right (November 17, 2003). EFA 2005 Moscow Meetings Paper. Available at SSRN: https://ssrn.com/abstract=680121 or http://dx.doi.org/10.2139/ssrn.680121

Randolph B. Cohen (Contact Author)

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6674 (Phone)
617-496-6592 (Fax)

Christopher Polk

London School of Economics ( email )

United Kingdom

HOME PAGE: http://personal.lse.ac.uk/polk/

Tuomo Vuolteenaho

Arrowstreet Capital, LP ( email )

44 Brattle St., 5th Floor
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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