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Stock Valuation and Learning about Profitability

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  • Veronesi, Pietro
  • Pástor, LuboÅ¡

Abstract

We develop a simple approach to valuing stocks in the presence of learning about average profitability. The market-to-book ratio (M/B) increases with uncertainty about average profitability, especially for firms that pay no dividends. M/B is predicted to decline over a firm's lifetime due to learning, with steeper decline when the firm is young. These predictions are confirmed empirically. Data also support the predictions that younger stocks and stocks that pay no dividends have more volatile returns. Firm profitability has become more volatile recently, helping explain the puzzling increase in average idiosyncratic return volatility observed over the past few decades.

Suggested Citation

  • Veronesi, Pietro & Pástor, LuboÅ¡, 2002. "Stock Valuation and Learning about Profitability," CEPR Discussion Papers 3410, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:3410
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    References listed on IDEAS

    as
    1. Randolph B. Cohen & Christopher Polk & Tuomo Vuolteenaho, 2003. "The Value Spread," Journal of Finance, American Finance Association, vol. 58(2), pages 609-641, April.
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    3. Jovanovic, Boyan, 1982. "Selection and the Evolution of Industry," Econometrica, Econometric Society, vol. 50(3), pages 649-670, May.
    4. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    5. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
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    More about this item

    Keywords

    Valuation; Learning; Uncertainty; Profitability; Market to book;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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    This paper has been announced in the following NEP Reports:

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