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Predicting Returns With Financial Ratios

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Author Info
Lewellen, Jonathan
Abstract

This article provides a new test of the predictive ability of aggregate financial ratios. Predictive regressions are subject to small-sample biases, but the correction in previous studies can substantially understate forecasting power. Dividend yield predicts aggregate market returns from 1946 Â€Ó 2000, as well as in various subperiods. Book-to-market and the earnings-price ratio predict returns during the shorter 1963 Â€Ó 2000 sample. The evidence remains strong despite the unusual price run-up in recent years

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File URL: http://hdl.handle.net/1721.1/1805
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Paper provided by Massachusetts Institute of Technology (MIT), Sloan School of Management in its series Working papers with number 4374-02.

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Date of creation: 27 Jan 2003
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Handle: RePEc:mit:sloanp:1805

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Postal: MASSACHUSETTS INSTITUTE OF TECHNOLOGY (MIT), SLOAN SCHOOL OF MANAGEMENT, 50 MEMORIAL DRIVE CAMBRIDGE MASSACHUSETTS 02142 USA

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Keywords: Predictive Regressions; Expected Returns; Small-sample Bias;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Hamilton, James D. & Whiteman, Charles H., 1985. "The observable implications of self-fulfilling expectations," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 353-373, November. [Downloadable!] (restricted)
  2. Goetzmann, William Nelson & Jorion, Philippe, 1993. " Testing the Predictive Power of Dividend Yields," Journal of Finance, American Finance Association, vol. 48(2), pages 663-79, June. [Downloadable!] (restricted)
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  3. Eugene F. Fama & Kenneth R. French, 2002. "The Equity Premium," Journal of Finance, American Finance Association, vol. 57(2), pages 637-659, 04. [Downloadable!] (restricted)
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  4. Kothari, S. P. & Shanken, Jay, 1997. "Book-to-market, dividend yield, and expected market returns: A time-series analysis," Journal of Financial Economics, Elsevier, vol. 44(2), pages 169-203, May. [Downloadable!] (restricted)
  5. Owen Lamont, 1998. "Earnings and Expected Returns," Journal of Finance, American Finance Association, vol. 53(5), pages 1563-1587, October. [Downloadable!] (restricted)
  6. Andrew Ang & Geert Bekaert, 2001. "Stock Return Predictability: Is it There?," NBER Working Papers 8207, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  7. Diba, Behzad T & Grossman, Herschel I, 1988. "Explosive Rational Bubbles in Stock Prices?," American Economic Review, American Economic Association, vol. 78(3), pages 520-30, June.
  8. Gregory Mankiw, N. & Shapiro, Matthew D., 1986. "Do we reject too often? : Small sample properties of tests of rational expectations models," Economics Letters, Elsevier, vol. 20(2), pages 139-145. [Downloadable!] (restricted)
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  9. Flood, Robert P & Hodrick, Robert J, 1990. "On Testing for Speculative Bubbles," Journal of Economic Perspectives, American Economic Association, vol. 4(2), pages 85-101, Spring. [Downloadable!] (restricted)
  10. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October. [Downloadable!] (restricted)
  11. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 5(3), pages 357-86. [Downloadable!] (restricted)
  12. Flood, Robert P & Hodrick, Robert J, 1986. " Asset Price Volatility, Bubbles, and Process Switching," Journal of Finance, American Finance Association, vol. 41(4), pages 831-42, September. [Downloadable!] (restricted)
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  13. Robert F. Stambaugh, 1999. "Predictive Regressions," NBER Technical Working Papers 0240, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  14. Kothari, S P & Shanken, Jay & Sloan, Richard G, 1995. " Another Look at the Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 50(1), pages 185-224, March. [Downloadable!] (restricted)
  15. Nelson, Charles R & Kim, Myung J, 1993. " Predictable Stock Returns: The Role of Small Sample Bias," Journal of Finance, American Finance Association, vol. 48(2), pages 641-61, June. [Downloadable!] (restricted)
  16. Pontiff, Jeffrey & Schall, Lawrence D., 1998. "Book-to-market ratios as predictors of market returns1," Journal of Financial Economics, Elsevier, vol. 49(2), pages 141-160, August. [Downloadable!] (restricted)
  17. DeJong, David N & Whiteman, Charles H, 1991. "The Temporal Stability of Dividends and Stock Prices: Evidence from the Likelihood Function," American Economic Review, American Economic Association, vol. 81(3), pages 600-617, June. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Yakov Amihud & Clifford Hurvich, 2004. "Predictive Regressions: A Reduced-Bias Estimation Method," Econometrics 0412008, EconWPA. [Downloadable!]
    Other versions:
  2. Hjalmarsson, Erik, 2005. "Predictive regressions with panel data," Working Papers in Economics 160, Göteborg University, Department of Economics. [Downloadable!]
  3. Cheolbeom Park, 2006. "The Persistence and Predictive Power of the Dividend-Price Ratio," Departmental Working Papers wp0603, National University of Singapore, Department of Economics. [Downloadable!]
  4. Yakov Amihud & Clifford Hurvich & Yi Wang, 2004. "Hypothesis Testing in Predictive Regressions," Finance 0412022, EconWPA. [Downloadable!]
  5. Hjalmarsson, Erik, 2005. "On the Predictability of Global Stock Returns," Working Papers in Economics 161, Göteborg University, Department of Economics. [Downloadable!]
  6. John Y. Campbell & Motohiro Yogo, 2003. "Efficient Tests of Stock Return Predictability," NBER Working Papers 10026, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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