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The Price is (Almost) Right

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  • Randolph B. Cohen
  • Christopher Polk
  • Tuomo Vuolteenaho

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 risk-adjusted fundamental value and mispricing. When we allow the discount rates to vary with cash-flow betas, the variance share of mispricing is negligible.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10131.

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Date of creation: Dec 2003
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Publication status: published as Randolph B. Cohen & Christopher Polk & Tuomo Vuolteenaho, 2009. "The Price Is (Almost) Right," Journal of Finance, American Finance Association, vol. 64(6), pages 2739-2782, December.
Handle: RePEc:nbr:nberwo:10131

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Citations

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Cited by:
  1. John Y. Campbell & Tuomo Vuolteenaho, 2004. "Bad Beta, Good Beta," American Economic Review, American Economic Association, American Economic Association, vol. 94(5), pages 1249-1275, December.
  2. Chen, Huafeng (Jason), 2011. "Firm life expectancy and the heterogeneity of the book-to-market effect," Journal of Financial Economics, Elsevier, Elsevier, vol. 100(2), pages 402-423, May.
  3. Lewellen, Jonathan, 2010. "Accounting anomalies and fundamental analysis: An alternative view," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 50(2-3), pages 455-466, December.
  4. Dong Lou & Christopher Polk, . "Inferring Arbitrage Activity from Return Correlations," FMG Discussion Papers, Financial Markets Group dp721, Financial Markets Group.
  5. Nitschka, Thomas, 2006. "Does sensitivity to cashflow news explain the value premium on European stock markets?," Technical Reports, Technische Universität Dortmund, Sonderforschungsbereich 475: Komplexitätsreduktion in multivariaten Datenstrukturen 2006,12, Technische Universität Dortmund, Sonderforschungsbereich 475: Komplexitätsreduktion in multivariaten Datenstrukturen.
  6. Malcolm Baker & Stefan Nagel & Jeffrey Wurgler, 2007. "The Effect of Dividends on Consumption," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 38(1), pages 231-292.
  7. repec:wyi:journl:002153 is not listed on IDEAS
  8. Jean-François Casta & Luc Paugam & Hervé Stolowy, 2011. "Non-additivity in accounting valuation: Internally generated goodwill as an aggregation of interacting assets," Post-Print, HAL halshs-00541525, HAL.
  9. Santos, Tano & Veronesi, Pietro, 2010. "Habit formation, the cross section of stock returns and the cash-flow risk puzzle," Journal of Financial Economics, Elsevier, Elsevier, vol. 98(2), pages 385-413, November.
  10. Hui Guo & Robert Savickas & Zijun Wang & Jian Yang, 2006. "Is value premium a proxy for time-varying investment opportunities: some time series evidence," Working Papers, Federal Reserve Bank of St. Louis 2005-026, Federal Reserve Bank of St. Louis.
  11. Paugam, Luc, 2011. "Valorisation et reporting du goodwill : enjeux théoriques et empiriques," Economics Thesis from University Paris Dauphine, Paris Dauphine University, Paris Dauphine University, number 123456789/8007 edited by Casta, Jean-François.
  12. Tano Santos & Pietro Veronesi, 2005. "Cash-Flow Risk, Discount Risk, and the Value Premium," NBER Working Papers 11816, National Bureau of Economic Research, Inc.
  13. Alan Gregory & Julie Whittaker, 2013. "Exploring the Valuation of Corporate Social Responsibility—A Comparison of Research Methods," Journal of Business Ethics, Springer, Springer, vol. 116(1), pages 1-20, August.
  14. Ravi Jagannathan & Srikant Marakani, 2011. "Price Dividend Ratio Factors : Proxies for Long Run Risk," NBER Working Papers 17484, National Bureau of Economic Research, Inc.

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