A UK Test of an Inflation-Adjusted Ohlson Model

48 Pages Posted: 27 Apr 2005

See all articles by Alan Gregory

Alan Gregory

University of Exeter - Xfi Centre; University of Exeter Business School

Walid Saleh

The Hashemite University

Jon Tucker

UWE Bristol; Coventry University

Abstract

This paper conducts a UK test of a version of the Ohlson (1995) model. We should only expect abnormal earnings to revert to zero if the book value of assets is economically meaningful. In this paper we make use of the property revaluations common in UK accounts, but estimate other asset values and earnings in inflation-adjusted terms. This, we argue, gives rise to estimates of abnormal earnings that can reasonably be expected to revert to zero. We then test this modified model on UK data using the Dechow, Hutton and Sloan (1999) method. In line with the predictions of the Ohlson model, we find that these modified abnormal earnings appear to mean revert, and that a first order autoregressive process is sufficient to capture the persistence of UK real abnormal earnings. The modified abnormal earnings model in general predicts one year ahead earnings more successfully than an unmodified model. Furthermore, for much of the sample period, one year ahead predictions of abnormal earnings are better for the real model during periods of higher inflation. The undervaluation problem found in prior studies appears to be replaced with an overvaluation problem in the real model which is more acute during periods of high inflation. Last, we show that an estimate of the model based upon an industry level specification appears to perform no better than a market-wide specification of the model.

Suggested Citation

Gregory, Alan and Saleh, Walid and Tucker, Jon, A UK Test of an Inflation-Adjusted Ohlson Model. Journal of Business Finance & Accounting, Vol. 32, No. 3-4, pp. 487-534, April 2005, Available at SSRN: https://ssrn.com/abstract=708657

Alan Gregory (Contact Author)

University of Exeter - Xfi Centre ( email )

University of Exeter
Xfi Building, Rennes Dr.
Exeter, EX4 3BZ
United Kingdom

University of Exeter Business School ( email )

Streatham Court
Xfi Building Rennes Dr.
Exeter, EX4 4JH
United Kingdom

Walid Saleh

The Hashemite University

P.O. Box 150459
Zarqa, 13115
Jordan

Jon Tucker

UWE Bristol ( email )

Frenchay Campus
Coldharbour Lane
Bristol, Avon BS16 1QY
United Kingdom

Coventry University ( email )

Priory Street
Coventry, CV1 5FB
United Kingdom

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