Stock Return Predictability of Residual-Income-Based Valuation: Risk or Mispricing?

Authors


  • We would like to thank Stewart Jones (Editor), David Johnstone (Associate Editor), three anonymous referees, Simon Fung, Byoung Kang, Jay Junghun Lee and Charlie Sohn for their helpful suggestions and comments. This paper has also benefited from comments by workshop participants at the Seoul National University and seminar participants at the 2007 Korean Accounting Association summer conference and the 19th Asian Pacific Conference. We also acknowledge financial assistance from the Korean Accounting Association, The Hong Kong Polytechnic University, and the Institute of Management Research and the Center for Accounting Research at Seoul National University's Graduate School of Business All errors are our own.

Abstract

In an influential paper, Frankel and Lee (1998) conclude that the stock return predictability of the value-to-price ratio (V/P) results from market mispricing. This paper confirms whether the V/P reflects the rational risk premiums associated with the V/P factor or is better explained by market inefficiency. Following Daniel and Titman (1997), this paper examines whether the V/P characteristics or the V/P factor loadings predict stock returns. The findings show that the V/P loadings are positively associated with average returns even after controlling for the V/P characteristics in both time series and cross-sectional tests. The overall results suggest that the mispricing explanation of the V/P effect is premature.

Ancillary