TAILIEUCHUNG - P/E and PRICE-to-BOOK RATIOS as PREDICTORS of STOCK RETURNS IN EMERGING EQUITY MARKETS

The past ten years are witness to many changes in line with this objective. Trading and settlement procedures have been improved. New instruments have been introduced. Disclosure levels have been enhanced. Measures to protect investors’ interest and educate them have been initiated at least on paper. A code of corporate governance has been put in place. Steps were initiated to change the organisational structure of the stock exchanges. Notwithstanding these improvements, the experience leaves one wondering how far the heavy emphasis placed on the stock market for allocating resources is justified. . | P E and PRICE-to-BOOK RATIOS as PREDICTORS of STOCK RETURNS IN EMERGING EQUITY MARKETS Kur at Aydogan Faculty of Business Administration Bilkent University Bilkent 06533 Ankara TURKEY E-mail aydogan@ and Guner Gursoy Faculty of Business Administration BilkentUniversity Bilkent 06533 Ankara TURKEY E-mail gursoy@ August 2000 Corresponding Author P E and PRICE-to-BOOK RATIOS as PREDICTORS of STOCK RETURNS IN EMERGING EQUITY MARKETS Recent research in empirical finance has shown that variables like dividend yields price-to-earnings P E ratios book-to-market ratios as well as past returns have significant explanatory power for the variation in cross section of expected returns even after controlling for market risk see for example Fama and French 1992 for a through coverage of the topic . Similar results are reported for several developed markets Ferson and Harvey 1997 Fama and French 1998 as well as emerging markets Bekaeert et. al. 1997 Claessens Dasgupta and Glen 1998 Patel 1998 Rouwenhorst 1999 . Whether these variables are risk proxies in an efficient market or signs of mispricing is the subject an ongoing debate in financial economics. Yet for the practitioner in the market it is the longer term predictive ability rather than contemporaneous explanatory power that is really important. In addition apart from forecasting individual stock returns stock market investors are also interested in the forecasting power of market wide averages of variables like dividend yield P E and book-to-market ratios as tools in market timing in highly volatile stock markets. The objective of this paper is to investigate the ability of average P E and book-to-market ratios to predict future stock market returns in emerging equity markets. Emerging markets are differentiated from developed markets with respect to their heterogeneous nature and inherent dynamics. These are the markets characterized by high volatility and high average returns. It has been shown

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