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Type: Journal article
Title: Dynamic risk, accounting-based valuation and firm fundamentals
Author: Lyle, M.
Callen, J.
Elliott, R.
Citation: Review of Accounting Studies, 2013; 18(4):899-929
Publisher: Springer New York LLC
Issue Date: 2013
ISSN: 1380-6653
Statement of
Matthew R. Lyle, Jeffrey L. Callen, Robert J. Elliott
Abstract: This study extends the accounting-based valuation framework of Ohlson (Contemp Acc Res 11(2):661–687, 1995) and Feltham and Ohlson (Acc Rev 74(2):165–183, 1999) to incorporate dynamic expectations about the level of systematic risk in the economy. Our model explains recent empirical findings documenting a strong negative association between changes in economy-wide risk and future stock returns. Importantly, the model also generates costs of capital that are solely a linear function of accounting variables and other firm fundamentals, including the book-to-market ratio, the earnings-to-price ratio, the forward earnings-to-price ratio, size and the dividend yield. This result provides a theoretical rationale for the inclusion of these popular variables in cost of capital (expected return) computations by the accounting and finance literatures and obviates the need to estimate costs of capital from unobservable (future) covariances. The model also generates an accounting return decomposition in the spirit of Vuolteenaho (J Finance 57(1):233–264, 2002). Empirically, we find that costs of capital generated by our model are significantly associated with future returns both in and out of sample in contrast to standard benchmark models. We further obtain significantly lower valuation errors in out-of-sample tests than traditional models that ignore dynamic risk expectations.
Keywords: Dynamic risk
accounting valuation
cost of capital
firm fundamentals
Rights: © Springer Science+Business Media New York 2013
DOI: 10.1007/s11142-013-9227-x
Appears in Collections:Aurora harvest
Mathematical Sciences publications

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