IS THE BOOK‐TO‐MARKET RATIO A MEASURE OF RISK?

Robert F. Peterkort and James F. Nielsen

Journal of Financial Research, 2005, vol. 28, issue 4, 487-502

Abstract: We develop a leverage‐based alternative to traditional asset pricing models to investigate whether the book‐to‐market ratio acts as a proxy for risk. We argue that the book‐to‐market ratio should act as a proxy because of the expected relations between (1) financial risk and measures of capital structure based on the market value of equity and (2) asset risk and measures of capital structure based on the book value of equity. We find no relation between average stock returns and the book‐to‐market ratio in all‐equity firms after controlling for firm size, and an inverse relation between average stock returns and the book‐to‐market ratio in firms with a negative book value of equity.

Date: 2005
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