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The Price is (Almost) Right

  • Randolph B. Cohen
  • Christopher Polk
  • Tuomo Vuolteenaho

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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File URL: http://www.nber.org/papers/w10131.pdf
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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
Note: AP
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