Abstract
We investigate the question whether the book to market ratio acts as a “risk-based” or “mispricing-based” proxy for share price formation in Chinese markets. We find that a strong relationship is observed between the firms’ book to market ratio and stock returns both in current and following years, while we cannot find a steady relationship between market leverage ratio and stock returns. In addition, the findings support the notion that a mispricing-based explanation is more plausible in China due to the speculative features of the Chinese markets.
Highlights
The book to market effect for stock returns remains inconclusive in the finance literature. Fama and French (1992) argue that book to market ratio has more explanatory power for the cross section of average stock returns than beta does based on the empirically evidence from their study
The bivariate sorting is conducted as follows: (1) for each year in our sample, we sort firms into five market leverage (MLEV) quintile portfolios; (2) we sort each of the MLEV quintile portfolios to create five B/M sub-quintile portfolios, which provides 25 portfolios for each year in the sample; (3) the mean value of B/M, book leverage (BLEV) and average stock return are calculated for each portfolio for each year
This study aims to examine the relationship between book to market ratio and stock returns in Chinese markets
Summary
The book to market effect for stock returns remains inconclusive in the finance literature. Fama and French (1992) argue that book to market ratio has more explanatory power for the cross section of average stock returns than beta does based on the empirically evidence from their study. The book to market effect for stock returns remains inconclusive in the finance literature. Fama and French (1992) argue that book to market ratio has more explanatory power for the cross section of average stock returns than beta does based on the empirically evidence from their study. Value strategies supporters argue that stock with low price to earnings ratio outperform the market (Basu, 1977; Chan et al 1991; Fama & French, 1992; Noda et al 2016). The interpretation of these empirical findings remains controversial. We have two competing theories to explain this phenomenon. It is fair to say that no single hypothesis has received overwhelming empirical support to reject reasonable alternative explanations
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