Book-to-Market Ratio

Abstract

The book-to-market ratio is the book value of equity divided by market value of equity. The underlined book-to-market effect is also termed as value effect. The book-to-market effect is well documented in finance. In general, high book-to-market stocks, also referred as value stocks, earn significant positive excess returns while low book-to-market stocks, also referred as growth stocks, earn significant negative excess returns. Both, Fama and French (1992) and Lakonishok, Shleifer, and Vishny (1994) reported that book-to-market ratio is strongly correlated with the stock’s future performance and highlight it as a popular return predictor. They are, however, in disagreement concerning the source of book-to-market effect: Fama and French (1992) attribute this to unobserved risk factors, while Lakonishok, Shleifer, and Vishny (1994) attribute it to mispricing. As a result, the observed correlation might be originated from risk-related factors as well as mispricing.