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Market Expectations in the Cross‐Section of Present Values
Author(s) -
KELLY BRYAN,
PRUITT SETH
Publication year - 2013
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12060
Subject(s) - predictability , economics , econometrics , valuation (finance) , cash flow , financial economics , value premium , stock market , momentum (technical analysis) , aggregate (composite) , sample (material) , stock (firearms) , capital asset pricing model , statistics , mathematics , finance , geography , chromatography , context (archaeology) , materials science , chemistry , archaeology , composite material
Returns and cash flow growth for the aggregate U.S. stock market are highly and robustly predictable. Using a single factor extracted from the cross‐section of book‐to‐market ratios, we find an out‐of‐sample return forecasting R 2 of 13% at the annual frequency (0.9% monthly). We document similar out‐of‐sample predictability for returns on value, size, momentum, and industry portfolios. We present a model linking aggregate market expectations to disaggregated valuation ratios in a latent factor system. Spreads in value portfolios’ exposures to economic shocks are key to identifying predictability and are consistent with duration‐based theories of the value premium.

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