[go: up one dir, main page]
IDEAS home Printed from https://ideas.repec.org/a/tei/journl/v13y2020i3p56-69.html
   My bibliography  Save this article

The British Stock Market under the Structure of Market Capitalization Value: New Evidence on its Predictive Content

Author

Listed:
  • Catherine Georgiou

    (Business Division, Department of Economics, Aristotle University of Thessaloniki, 54124, Thessaloniki, Greece)

Abstract
Purpose: The aim of our paper is twofold. First, we examine the predictive ability of log book-market, dividend-price, earnings-price and dividend-earnings ratios on the most recent data set of the strongest securities in the UK economy; unlike the majority of the studies in this data set, our analysis is not limited on returns but further investigates dividend and earnings growth predictability under the presence of the most recent global financial recession. Second, we exploit the long-run equilibrium relationship in two systems, [p_t,d_t,e_t] and [p_t,b_t,e_t] and examine the predictive ability of our newly formed variables, namely [pde]_t and [pbe]_t. Design/methodology/approach: In this study, we examine the most recent data set of Financial Times Stock Exchange 100 (FTSE 100) and analyze it based on the formation of size portfolios. The main focus is placed on the index’s returns, dividend and earnings growth rates and the predictive ability of the four financial ratios we have selected following their reputation as strong predictors. We also formulate two extra ratios based on their long-run equilibrium relationship. Finding: Our study’s main findings can be summarized as following. First, we retrieve evidence that in-sample return predictability is evident in the medium and large-sized portfolios and is better captured by [pde]_t at 35% and 47% equivalently. Second, forecasts on dividend growth are even more linked to the size criterion we employ. Third, in-sample regressions of continuously compounded earnings growth rate show that most predictive benefits are obtained by [dp]_t in the medium portfolio with an R^2 of 45%. Research limitations/implications: A first constraint is the forecasters we employ; we have used the most indicative ones due to their popularity in similar data sets but there are other macroeconomic variables such as spreads and interest rates that could be tested in future research. Also, we could examine the sensitivity of our results on whether we use nominal, excess or real returns and then, attempt to alter our data’s frequency so as to address the seasonality effect observed mainly in dividends and earnings. Originality/value: We believe that our paper contributes to the ongoing debate of the traits that make return predictable and the information included in either dividends or earnings to explain that predictability. Finally, the novelty of this paper lies in the links it tries to retrieve among market capitalization value and predictability in a market whose predictive components have not been entirely explored. Our paper may prove informative to investors focused on short-term forecasting and interested in the effects of size in portfolio formation.

Suggested Citation

  • Catherine Georgiou, 2020. "The British Stock Market under the Structure of Market Capitalization Value: New Evidence on its Predictive Content," International Journal of Business and Economic Sciences Applied Research (IJBESAR), Democritus University of Thrace (DUTH), Kavala Campus, Greece, vol. 13(3), pages 56-69, December.
    • Handle: RePEc:tei:journl:v:13:y:2020:i:3:p:56-69
    as

    Download full text from publisher

    File URL: https://ijbesar.af.duth.gr/docs/volume13_issue3/13_03_05.pdf
    Download Restriction: no
    File URL: https://ijbesar.af.duth.gr/volume13_issue3.php
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Ivo Welch & Amit Goyal, 2008. "A Comprehensive Look at The Empirical Performance of Equity Premium Prediction," The Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1455-1508, July.
    2. repec:bla:jfinan:v:53:y:1998:i:5:p:1563-1587 is not listed on IDEAS
    3. Anne Vila Wetherilt & Simon Wells, 2004. "Long-horizon equity return predictability: some new evidence for the United Kingdom," Bank of England working papers 244, Bank of England.
    4. Andrew Ang & Geert Bekaert, 2007. "Stock Return Predictability: Is it There?," The Review of Financial Studies, Society for Financial Studies, vol. 20(3), pages 651-707.
    5. Campbell, John Y, 1991. "A Variance Decomposition for Stock Returns," Economic Journal, Royal Economic Society, vol. 101(405), pages 157-179, March.
    6. Kothari, S.P. & Lewellen, Jonathan & Warner, Jerold B., 2006. "Stock returns, aggregate earnings surprises, and behavioral finance," Journal of Financial Economics, Elsevier, vol. 79(3), pages 537-568, March.
    7. Walter Torous & Rossen Valkanov & Shu Yan, 2004. "On Predicting Stock Returns with Nearly Integrated Explanatory Variables," The Journal of Business, University of Chicago Press, vol. 77(4), pages 937-966, October.
    8. John Y. Campbell & Robert J. Shiller, 2001. "Valuation Ratios and the Long-Run Stock Market Outlook: An Update," NBER Working Papers 8221, National Bureau of Economic Research, Inc.
    9. Campbell, John Y. & Yogo, Motohiro, 2006. "Efficient tests of stock return predictability," Journal of Financial Economics, Elsevier, vol. 81(1), pages 27-60, July.
    10. Martin Lettau & Sydney Ludvigson, 2001. "Consumption, Aggregate Wealth, and Expected Stock Returns," Journal of Finance, American Finance Association, vol. 56(3), pages 815-849, June.
    11. Søren Johansen & Rocco Mosconi & Bent Nielsen, 2000. "Cointegration analysis in the presence of structural breaks in the deterministic trend," Econometrics Journal, Royal Economic Society, vol. 3(2), pages 216-249.
    12. Garrett, Ian & Priestley, Richard, 2012. "Dividend Growth, Cash Flow, and Discount Rate News," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 47(5), pages 1003-1028, October.
    13. Teets, Walter R. & Wasley, Charles E., 1996. "Estimating earnings response coefficients: Pooled versus firm-specific models," Journal of Accounting and Economics, Elsevier, vol. 21(3), pages 279-295, June.
    14. Lettau, Martin & Ludvigson, Sydney C., 2005. "Expected returns and expected dividend growth," Journal of Financial Economics, Elsevier, vol. 76(3), pages 583-626, June.
    15. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October.
    16. Fletcher, Jonathan, 2001. "An examination of predictable risk and return in UK stock returns," Journal of Economics and Business, Elsevier, vol. 53(6), pages 527-546.
    17. Catherine Georgiou & Chris Grose & Fragiskos Archontakis, 2019. "Predictable risks and returns: further evidence from the UK stock market," International Journal of Financial Markets and Derivatives, Inderscience Enterprises Ltd, vol. 7(1), pages 68-100.
    18. Li, GuangJie, 2009. "The Horizon Effect of Stock Return Predictability and Model Uncertainty on Portfolio Choice: UK Evidence," Cardiff Economics Working Papers E2009/4, Cardiff University, Cardiff Business School, Economics Section, revised Aug 2009.
    19. Clare, A. D. & Smith, P. N. & Thomas, S. H., 1997. "UK stock returns and robust tests of mean variance efficiency," Journal of Banking & Finance, Elsevier, vol. 21(5), pages 641-660, May.
    20. Born, Benjamin & Müller, Gernot J. & Schularick, Moritz & Sedlacek, Petr, 2017. "The economic consequences of the Brexit Vote," LSE Research Online Documents on Economics 87174, London School of Economics and Political Science, LSE Library.
    21. Campbell, John Y. & Viceira, Luis M., 2002. "Strategic Asset Allocation: Portfolio Choice for Long-Term Investors," OUP Catalogue, Oxford University Press, number 9780198296942.
    22. Sadka, Gil & Sadka, Ronnie, 2009. "Predictability and the earnings-returns relation," Journal of Financial Economics, Elsevier, vol. 94(1), pages 87-106, October.
    23. Blume, Marshall E, 1970. "Portfolio Theory: A Step Toward Its Practical Application," The Journal of Business, University of Chicago Press, vol. 43(2), pages 152-173, April.
    24. Søren Johansen & Rocco Mosconi & Bent Nielsen, 2000. "Cointegration analysis in the presence of structural breaks in the deterministic trend," Econometrics Journal, Royal Economic Society, vol. 3(2), pages 216-249.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Boudoukh, Jacob & Israel, Ronen & Richardson, Matthew, 2022. "Biases in long-horizon predictive regressions," Journal of Financial Economics, Elsevier, vol. 145(3), pages 937-969.
    2. Catherine Georgiou, 2022. "Modifications on Book-Valued Ratios," International Journal of Business and Economic Sciences Applied Research (IJBESAR), Democritus University of Thrace (DUTH), Kavala Campus, Greece, vol. 15(3), pages 24-37, December.
    3. Ilaria Piatti & Fabio Trojani, 2020. "Dividend Growth Predictability and the Price–Dividend Ratio," Management Science, INFORMS, vol. 66(1), pages 130-158, January.
    4. Park, Dojoon & Hahn, Jaehoon & Eom, Young Ho, 2024. "Predicting the equity premium with financial ratios: A comprehensive look over a long period in Korea," Pacific-Basin Finance Journal, Elsevier, vol. 84(C).
    5. Martin Lettau & Stijn Van Nieuwerburgh, 2008. "Reconciling the Return Predictability Evidence," The Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1607-1652, July.
    6. John Y. Campbell & Samuel B. Thompson, 2005. "Predicting the Equity Premium Out of Sample: Can Anything Beat the Historical Average?," Harvard Institute of Economic Research Working Papers 2084, Harvard - Institute of Economic Research.
    7. Chen, Long, 2009. "On the reversal of return and dividend growth predictability: A tale of two periods," Journal of Financial Economics, Elsevier, vol. 92(1), pages 128-151, April.
    8. John Y. Campbell & Samuel B. Thompson, 2008. "Predicting Excess Stock Returns Out of Sample: Can Anything Beat the Historical Average?," The Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1509-1531, July.
    9. Giot, Pierre & Petitjean, Mikael, 2007. "The information content of the Bond-Equity Yield Ratio: Better than a random walk?," International Journal of Forecasting, Elsevier, vol. 23(2), pages 289-305.
    10. Jiang, Xiaoquan & Lee, Bong-Soo, 2007. "Stock returns, dividend yield, and book-to-market ratio," Journal of Banking & Finance, Elsevier, vol. 31(2), pages 455-475, February.
    11. repec:grz:wpaper:2012-02 is not listed on IDEAS
    12. Maio, Paulo & Santa-Clara, Pedro, 2012. "Multifactor models and their consistency with the ICAPM," Journal of Financial Economics, Elsevier, vol. 106(3), pages 586-613.
    13. Roelof Salomons, 2008. "A Theoretical And Practical Perspective On The Equity Risk Premium," Journal of Economic Surveys, Wiley Blackwell, vol. 22(2), pages 299-329, April.
    14. John H. Cochrane, 2008. "The Dog That Did Not Bark: A Defense of Return Predictability," The Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1533-1575, July.
    15. Ľuboš Pástor & Robert F. Stambaugh, 2009. "Predictive Systems: Living with Imperfect Predictors," Journal of Finance, American Finance Association, vol. 64(4), pages 1583-1628, August.
    16. Yu, Jialin, 2011. "Disagreement and return predictability of stock portfolios," Journal of Financial Economics, Elsevier, vol. 99(1), pages 162-183, January.
    17. Tim Bollerslev & George Tauchen & Hao Zhou, 2009. "Expected Stock Returns and Variance Risk Premia," The Review of Financial Studies, Society for Financial Studies, vol. 22(11), pages 4463-4492, November.
    18. Favero, Carlo A. & Gozluklu, Arie E. & Tamoni, Andrea, 2011. "Demographic Trends, the Dividend-Price Ratio, and the Predictability of Long-Run Stock Market Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 46(5), pages 1493-1520, October.
    19. Sadka, Gil & Sadka, Ronnie, 2009. "Predictability and the earnings-returns relation," Journal of Financial Economics, Elsevier, vol. 94(1), pages 87-106, October.
    20. Lof, Matthijs & Nyberg, Henri, 2024. "Discount rates and cash flows: A local projection approach," Journal of Banking & Finance, Elsevier, vol. 162(C).
    21. Bakshi, Gurdip & Panayotov, George & Skoulakis, Georgios, 2011. "Improving the predictability of real economic activity and asset returns with forward variances inferred from option portfolios," Journal of Financial Economics, Elsevier, vol. 100(3), pages 475-495, June.

    More about this item

    Keywords

    Return predictability; dividend growth; earnings growth; size portfolios; FTSE 100;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:tei:journl:v:13:y:2020:i:3:p:56-69. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Kostas Stergidis (email available below). General contact details of provider: https://edirc.repec.org/data/dbikagr.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.