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The fundamental-to-market ratio and the value premium decline

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  • Gonçalves, Andrei S.
  • Leonard, Gregory

Abstract

Recent evidence indicates the value premium declined over time. We argue this decline happened because book equity, BE, is no longer a good proxy for fundamental equity, FE, defined as the present value of cash flows under a common discount rate across firms. Specifically, we estimate FE for public US firms over time and find that the premium associated with the fundamental-to-market ratio, FE/ME, subsumes the BE/ME premium and has been relatively stable while the cross-sectional correlation between FE/ME and BE/ME decreased over time, inducing an apparent decline in the value premium. We also show that FE/ME captures the value premium better than several alternative value signals beyond BE/ME.

Suggested Citation

  • Gonçalves, Andrei S. & Leonard, Gregory, 2023. "The fundamental-to-market ratio and the value premium decline," Journal of Financial Economics, Elsevier, vol. 147(2), pages 382-405.
    • Handle: RePEc:eee:jfinec:v:147:y:2023:i:2:p:382-405
    DOI: 10.1016/j.jfineco.2022.11.001
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    More about this item

    Keywords

    Value premium; Book-to-market; Value signals; The cross-section of expected returns;
    All these keywords.

    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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