RIM-based Value Premium and Factor Pricing Using Value-Price Divergence
72 Pages Posted: 1 Mar 2017 Last revised: 10 Jan 2023
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RIM-based Value Premium and Factor Pricing Using Value-Price Divergence
Rim-Based Value Premium and Factor Pricing Using Value-Price Divergence
Date Written: April 24, 2018
Abstract
Value-to-Price, the ratio of Residual-Income-Model-based valuation to market price, subsumes the power of book-to-market and to a large extent of various quality measures in predicting stock returns. A natural hedge against momentum, long-short Value-to-Price strategies resuscitate the value premium and generate significant returns even after adjusting for common factors. The value-price-divergence (VPD) factor, constructed from the average returns of the long-short Value-to-Price portfolios within small and big stocks, is not spanned by known factor models. Max-Sharpe-ratio and constrained R-squared tests reveal that factor models replacing the traditional value factor with the VPD factor better explain the cross-section of expected equity returns.
Keywords: Asset Pricing, Factor Models, Mispricing, RIM, Value Premium.
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