RIM-based value premium and factor pricing using value-price divergence

Lin Cong, Nathan Darden George and Guojun Wang

Journal of Banking & Finance, 2023, vol. 149, issue C

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.

Keywords: Asset pricing; Factor models; Mispricing; RIM; Value Investing (search for similar items in EconPapers)
JEL-codes: C52 G11 G12 M41 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Working Paper: RIM-Based Value Premium and Factor Pricing Using Value-Price Divergence (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:149:y:2023:i:c:s0378426623000377

DOI: 10.1016/j.jbankfin.2023.106812

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