The price is (almost) right
By: Randolph B. Cohen, Christopher Polk, Tuomo Vuolteenaho
Contributors: Polk, Christopher; Vuolteenaho, Tuomo; Harvard Business School. Division of Research
Edition: Rev. 12/03.
Series: Working paper / Division of Research, Harvard Business School -- 03-107; Working paper (Harvard Business School. Division of Research) -- 03-107
Publisher: Division of Research, Harvard Business School
Published: 2003
Place of publication: Boston
Language: eng
Number of pages: 37
Description: Most previous research tests market efficiency and asset pricing models using average abnormal trading profits on dynamic trading strategies, and typically rejects the joint hypothesis. In contrast, we measure the ability of a simple risk model and the efficient-market hypothesis to explain the level of stock prices. First, we find that cash-flow beats (measured by regressing firms' earnings on the market's earnings) explain the prices of value and growth stocks well, with a plausible premium. Second, we use a present-value model to decompose the cross-sectional variance of firms' price-to-book ratios into two components due to risk-adjusted fundamental value and mispricing. When we allow the discount rates to vary as predicted by the CAPM, the variance share of mispricing is negligible.
Notes: "First draft: 12/31/2001. This draft: 11/17/2003"--Added t.p.

"An earlier draft of this paper was circulated under the title "Does risk or mispricing explain the cross-section of stock prices?" Some of the ideas in this paper were first presented as Section V of the paper titled "The value spread" at the NBER 2000 Summer Institute"--Added t.p.

Revision of: Does risk or mispricing explain the cross-section of stock prices? Division of Research, Harvard Business School, [c2003]. Series no. 03-107.

Includes bibliographical references.