Valentin Dimitrov

The Value-Relevance of Changes in Financial Leverage Beyond Growth in Assets and GAAP Earnings:

The economic performance of a firm is not directly observable. Prior research has shown that accounting earnings and cash flows measure the otherwise unobservable economic performance. However, these measures of performance are noisy and other variables can help us learn about economic performance. We argue that changes in financial leverage provide information about performance beyond what is available from earnings and cash flows. This concept is different from the traditional view in which financial leverage is a measure of risk. We show that changes in financial leverage are value-relevant beyond accounting earnings. As part of this analysis, we also provide evidence on the value-relevance of growth in assets. For both changes in financial leverage and growth in assets, we document that the information in these variables is incremental to the information in earnings, operating cash flows, and accruals. Although our focus is on contemporaneous returns, we also find that the market does not impound available information in changes in financial leverage in a timely fashion.

Reference-Day Risk: Observations and Extensions

Our paper confirms and extends the central result of Acker and Duck (2007) on reference-day risk. Using data from Datastream, they show substantial variations in the estimated monthly returns, variances, and betas across series beginning on different (reference) days of the same month. We show that the results are similar when we use data from the Center for Research in Security Prices daily files. We also show that reference-day risk extends to estimations based on daily returns. Finally, we find variations across series of daily returns computed using prices at different times of the day (reference-time risk). These findings carry potential implications for prior papers that rely on monthly or daily returns for analysis.

Shiller's CAPE: Market Efficiency and Risk

Robert Shiller shows that Cyclically Adjusted Price to Earnings Ratio (CAPE) is strongly associated with future long-term stock returns. This result has often been interpreted as evidence of market inefficiency. We present two findings that are contrary to such an interpretation. First, if markets are efficient, returns on average, even when conditional on CAPE, should be higher than the risk-free rate. We find that even when CAPE is in its ninth decile, future 10-year stock returns, on average, are higher than future returns on 10-year Treasurys. Thus, the results are largely consistent with market efficiency. Only when CAPE is very high, say, CAPE is in the upper half of the tenth decile (CAPE higher than 27.6), future 10-year stock returns, on average, are lower than those on 10-year U.S. Treasurys. Second, we provide a risk-based explanation for the association between CAPE and future stock returns. We find that CAPE and future stock returns are positively associated with future stock market volatility. Overall, CAPE levels do not seem to reflect market inefficiency and do reflect risk (volatility).