Expected returns dynamics implied by firm fundamentals
By: Matthew Lyle, Charles C.Y. Wang
Contributors: Wang, Charles C.Y.; Harvard Business School
Series: Working paper / Harvard Business School -- 13-050; Working paper (Harvard Business School) -- 13-050
Publisher: Harvard Business School
Published: 2013
Place of publication: Boston ]
Language: eng
Number of pages: 48
Work titles: Cost of capital dynamics implied by firm fundamentals
Description: We provide a tractable stock valuation model to study the dynamics of firm-level expected returns and their valuation impact using two firm fundamentals: book-to-market ratio and ROE. Applying the model to the cross-section of firms, we find that expected returns and expected profitability are highly persistent and time varying. Our fundamentals-implied estimates of expected returns across time horizons exhibit strong return predictability up to three years ahead and produce an aggregate equity term structure that tracks economic conditions. The implied term structure is upward sloping during normal or expansion periods but flattens or inverts during economic downturns or times of high uncertainty. Finally, we show that ignoring the dynamics of expected returns can produce large valuation errors.
Notes: "November 2012. (Revised March 2013.)" -- Publisher's website.

Revision of Cost of capital dynamics implied by firm fundamentals.

Includes bibliographical references (pages 28-30).