SSE/EFI Working Paper Series in Business Administration
No 2005:8:
Prediction of ROE and the Residual Income Valuation Model: Forecasting and Modeling Mispricing in the Swedish Stock Market
Stina Skogsvik ()
and Kenth Skogsvik ()
Abstract: Using Swedish data, the study investigates whether an
investment strategy based on publicly available financial statement
information can generate abnormal investment returns. The strategy involves
two steps. First, a financial statement based prediction model of changes
in the book return on owners’ equity (ROE) is estimated. Second, stock
market expectations of changes in ROE are assessed based on observed market
prices and the residual income valuation model. Market positions are taken
when the financial statement based predictions of ROE and market
expectations differ. Over the period 1983–2003, the investment strategy
generated an average market-adjusted hedge return of 48.4 % over 36-month
holding periods. About half of the returns appear to be due to forecasting
mispricing (i.e. stock prices failing to reflect financial statement based
predictions of ROE), leaving the remainder to be caused by modeling
mispricing (i.e. stock prices failing to reflect the valuation impact of
predicted ROE values). However, additional analyses show that the hedge
returns in the main are caused by the long position, and that the returns
have been affected by a positive market sentiment bias (i.e. positive ROE
surprises priced as being more permanent than negative ROE surprises) over
the period. Furthermore, most of the positive investment returns accrued
over holding periods up to around 1995, with no indications of market
mispricing over the last third of the investment period.
Keywords: Fundamental analysis; Return on owners' equity; Market efficiency; (follow links to similar papers)
50 pages, June 21, 2005, Revised April 20, 2009
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- This paper is published as:
-
Skogsvik, Stina and Kenth Skogsvik, (2010), 'Prediction of ROE and the Residual Income Valuation Model: Forecasting and Modeling Mispricing in the Swedish Stock Market', ABACUS, Vol. 46, No. 4, pages 387-418
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