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On the importance of clean accounting measures for the tests of stock market efficiency

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Abstract

Tests of the semi-strong form of the efficient market hypothesis (EMH) typically use earnings and book value of equity as benchmarks of fundamental value. Accounting earnings, however, are contaminated by noise due to their transient component and book value of equity tends to be biased downwards due to accounting conservatism. We investigate whether controlling for these effects impacts on the implications concerning the information efficiency of the Swedish stock market. We conclude that relevant adjustments increase both the magnitude and the consistency of the value premium earned on a contrarian investment strategy that buys (shorts) stocks with low (high) relative market valuation. The existence of the value premium cannot be explained by common risk proxies or transaction costs argument. Using cleaner accounting proxies thus strengthens the evidence on the imperfect efficiency of the Swedish stock market.

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Bibliographic Info

Paper provided by Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies in its series Working Papers IES with number 2007/25.

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Length: 61 pages
Date of creation: Sep 2007
Date of revision: Sep 2007
Handle: RePEc:fau:wpaper:wp2007_25

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Keywords: market efficiency; investment; contrarian strategy; transitory earnings; accounting conservatism; Sweden; Scandinavia;

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