Location of Repository

The Price is (Almost) Right

By Randolph B. Cohen, Christopher Polk and Tuomo Vuolteenaho


Most previous research tests market efficiency and asset pricing models using average abnormal trading profits on dynamic trading strategies, and typically rejects the joint hypothesis. In contrast, we measure the ability of a simple risk model and the efficient-market hypothesis to explain the level of stock prices. First, we find that cash-flow betas (measured by regressing firms' earnings on the market's earnings) explain the prices of value and growth stocks well, with a plausible premium. Second, we use a present-value model to decompose the cross-sectional variance of firms' price-to-book ratios into two components due to risk-adjusted fundamental value and mispricing. When we allow the discount rates to vary with cash-flow betas, the variance share of mispricing is negligible.

OAI identifier:

Suggested articles



  1. (2001). A generalized earnings model for stock valuation,
  2. (1987). A simple positive semi-definite heteroscedasticity and autocorrelation consistent covariance matrix,
  3. (1989). A test of the efficiency of a given portfolio,
  4. (1973). An intertemporal capital asset pricing model,
  5. (1995). Another look at the cross-section of expected stock returns,
  6. (2001). Asset Pricing,
  7. (2000). Characteristics, covariances, and average returns:
  8. (1993). Common risk factors in the returns on stocks and bonds,
  9. (2002). Consumption, dividends, and the cross-section of equity returns, unpublished working paper,
  10. (1994). Contrarian investment, extrapolation, and risk,
  11. (1986). Does the stock market rationally reflect fundamental values?,
  12. (1996). Dynamic Asset Pricing Theory,
  13. (1995). Earnings, book values, and dividends in equity valuation,
  14. (1970). Efficient capital markets,
  15. (1997). Equity-premium and risk-free-rate puzzles at long horizons,
  16. (1977). Estimating betas from nonsyncronous data,
  17. (1997). Evidence on the characteristics of cross-sectional variation in stock returns,
  18. (1992). Explaining the variance of price-dividend ratios,
  19. (1991). Fundamental value and market value,
  20. (1990). Habit formation: a resolution of the equity premium puzzle.”
  21. (1999). Implications of security market data for models of dynamic economies.”
  22. (2000). Inefficient Markets : An Introduction to Behavioral Finance,
  23. (2000). Inference in long-horizon event studies: A Bayesian approach with application to initial public offerings,
  24. (1980). Interfirm tender offers and the market for corporate control,
  25. (1998). Investor psychology and securities market under- and overreactions,
  26. (2001). Labor income and predictable stock returns, CRSP working paper,
  27. (1982). Large sample properties of generalized methods of moments estimators,
  28. (2002). Market timing and capital structure,
  29. (1996). Multifactor explanations of asset pricing anomalies,
  30. (1995). Multifactor models do not explain deviations from the Capital Asset Pricing Models.
  31. (1985). Persuasive evidence of market inefficiency,
  32. (1969). Portfolios theory and accounting,
  33. (1996). Rational capital budgeting in an irrational world,
  34. (1999). Residual earnings valuation with risk and stochastic interest rates,
  35. (2001). Resurrecting the (C)CAPM: a cross-sectional test when risk premia are time-varying,
  36. (1979). Risk measurement when shares are subject to infrequent trading,
  37. (1973). Risk, return, and equilibrium: empirical tests,
  38. Sensitivity of multivariate tests of the capital asset pricing model to the return measurement interval,
  39. (1995). Size and book-to-market factors in earnings and returns,
  40. (1978). Some anomalous evidence regarding market efficiency,”
  41. (2001). Stock market driven acquisitions, NBER working paper 8439.
  42. (1970). The association between market determined and accounting determined risk measures,
  43. (1972). The capital asset pricing model: Some empirical tests,
  44. (1996). The conditional CAPM and the cross-section of expected returns,
  45. (1958). The cost of capital, corporation finance, and the theory of investment,
  46. (1992). The cross-section of expected stock returns,
  47. (1997). The delisting bias in CRSP data,
  48. (2002). The equity premium,
  49. (1999). The rhetoric and reality of American dream: Securities legislation and the accounting profession in the 1930s, working paper,
  50. (1999). The shrinking equity premium,
  51. (1961). The Theory and
  52. (2001). The theory and practice of corporate finance: evidence from the field,
  53. (2002). The value spread, forthcoming in the Journal of Finance.
  54. (2001). Understanding the aggregate book-to-market ratio and its implications to current equity-premium expectations, working paper,
  55. (1991). Volatility tests and efficient markets: review essay,
  56. (2002). What drives firm-level returns?,

To submit an update or takedown request for this paper, please submit an Update/Correction/Removal Request.