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A framework for identifying accounting characteristics for asset pricing models, with an evaluation of book‐to‐price
Author(s) -
Penman Stephen H.,
Reggiani Francesco,
Richardson Scott A.,
Tuna İrem
Publication year - 2018
Publication title -
european financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.311
H-Index - 64
eISSN - 1468-036X
pISSN - 1354-7798
DOI - 10.1111/eufm.12171
Subject(s) - leverage (statistics) , earnings , capital asset pricing model , economics , book value , econometrics , earnings growth , earnings response coefficient , contrast (vision) , financial economics , arbitrage pricing theory , value (mathematics) , earnings yield , asset (computer security) , price–earnings ratio , accounting , earnings per share , mathematics , computer science , statistics , computer security , artificial intelligence
We provide a framework for identifying accounting numbers that indicate risk and expected return. Under specified accounting conditions for measuring earnings and book value, book‐to‐price (B/P) indicates expected returns, providing justification for B/P in asset pricing models. However, the framework also points to earnings‐to‐price (E/P) as a risk characteristic. Indeed, E/P, rather than B/P, is the relevant characteristic when there is no expected earnings growth, but the weight shifts to B/P with growth. Using this framework we resolve a puzzle: in contrast to previous empirical research, we find that leverage is positively associated with future returns, as predicted by theory.