A framework for identifying accounting characteristics for asset pricing models, with an evaluation of book‐to‐price. (17th April 2018)

• Record Type: Journal Article
• Authors: Penman, Stephen H.; Reggiani, Francesco; Richardson, Scott A.; Tuna, İrem
• Other Names: Zhang Lu guestEditor.
• Is Part Of: European financial management. Volume 24:Number 4(2018:Sep.)
• Page Start: 488
• Page End: 520
• Publication Date: 2018-04-17
• Subjects: accounting principles -- book‐to‐price -- earnings‐to‐price -- growth and risk; Finance -- European Union countries -- Periodicals; International finance -- Periodicals; Corporations -- European Union countries -- Finance -- Periodicals; 332.094
• DOI: 10.1111/eufm.12171
• Languages: English
• ISSNs: 1354-7798

Abstract

Abstract: 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.