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A UK Test of an Inflation‐Adjusted Ohlson Model

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  • Alan Gregory
  • Walid Saleh
  • Jon Tucker

Abstract

This paper conducts a UK test of a version of the Ohlson (1995) model. We should only expect abnormal earnings to revert to zero if the book value of assets is economically meaningful. In this paper we make use of the property revaluations common in UK accounts, but estimate other asset values and earnings in inflation‐adjusted terms. This, we argue, gives rise to estimates of abnormal earnings that can reasonably be expected to revert to zero. We then test this modified model on UK data using the Dechow, Hutton and Sloan (1999) method. In line with the predictions of the Ohlson model, we find that these modified abnormal earnings appear to mean revert, and that a first order autoregressive process is sufficient to capture the persistence of UK real abnormal earnings. The modified abnormal earnings model in general predicts one year ahead earnings more successfully than an unmodified model. Furthermore, for much of the sample period, one year ahead predictions of abnormal earnings are better for the real model during periods of higher inflation. The undervaluation problem found in prior studies appears to be replaced with an overvaluation problem in the real model which is more acute during periods of high inflation. Last, we show that an estimate of the model based upon an industry level specification appears to perform no better than a market‐wide specification of the model.

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  • Alan Gregory & Walid Saleh & Jon Tucker, 2005. "A UK Test of an Inflation‐Adjusted Ohlson Model," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 32(3‐4), pages 487-534, April.
    • Handle: RePEc:bla:jbfnac:v:32:y:2005:i:3-4:p:487-534
    DOI: 10.1111/j.0306-686X.2005.00602.x
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    2. Weetman, Pauline, 2006. "Discovering the ‘international’ in accounting and finance," The British Accounting Review, Elsevier, vol. 38(4), pages 351-370.
    3. Alessandro Mechelli & Riccardo Cimini, 2021. "The effect of corporate governance and investor protection environments on the value relevance of new accounting standards: the case of IFRS 9 and IAS 39," Journal of Management & Governance, Springer;Accademia Italiana di Economia Aziendale (AIDEA), vol. 25(4), pages 1241-1266, December.
    4. Nicholas Belesis & John Sorros & Alkiviadis Karagiorgos, 2020. "Financial Market Data Versus Accounting Data: Which Better Explains Stock Returns?," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 26(1), pages 59-72, February.

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