Journal of Banking & Finance Vol. 149 2023
RIM-based value premium and factor pricing using value-price divergence
Abstract
We document that value-to-price, the ratio of Residual-Income-Model-based valuation to market price, subsumes the power of book-to-market ratio and many other value or quality measures in predicting stock returns. Long-short value-to-price portfolios hedge against momentum, revitalize the seemingly missing value premium over past decades, and generate significant returns after adjusting for common factors. The value-price-divergence (VPD) factor constructed from the average returns of these portfolios within small and big stocks is not spanned by these known factors. Max Sharpe ratio and constrained R-squared tests reveal that VPD is a better substitute for the traditional value factor and that a four-factor model using the VPD, market, momentum, and size factors outperforms most extant benchmarks in explaining the cross-section of expected equity returns, including value-to-price portfolios as test assets. The findings remain robust under alternative specifications of equity cost of capital.
- DOI
- 10.1016/j.jbankfin.2023.106812
- Volume
- 149
- Pages
- 106812
- Language
- en
- Sources
- openalex crossref bibtex:phds-export.bib