RIM-Based Value Premium and Factor Pricing Using Value-Price Divergence

Lin Cong, Nathan Darden George and Guojun Wang

No 30967, NBER Working Papers from National Bureau of Economic Research, Inc

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 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. The findings remain robust under alternative specifications of equity cost of capital.

JEL-codes: C52 G11 G12 M41 (search for similar items in EconPapers)
Date: 2023-02
New Economics Papers: this item is included in nep-fmk
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Published as Lin William Cong & Nathan Darden George & Guojun Wang, 2023. "RIM-based value premium and factor pricing using value-price divergence," Journal of Banking & Finance, vol 149.

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