Fundamental determinants of national equity market returns: A perspective on conditional asset pricing

This paper provides a global asset pricing perspective on the debate over the relation between predetermined attributes of common stocks, such as ratios of price-to-bookvalue, cash̄ow, earnings, and other variables to the future returns. Some argue that such variables may be used to ®nd securities that are systematically undervalued by the market, while others argue that the measures are proxies for exposure to underlying economic risk factors. It is not possible to distinguish between these views without explicitly modelling the relation between such attributes and risk factors. We present an empirical framework for attacking the problem at a global level, assuming integrated markets. Our perspective pulls together the traditional academic and practitioner viewpoints on lagged attributes. We present new evidence on the relative importance of risk and mispricing e€ects, using monthly data for 21 national equity markets. We ®nd that the cross-sectional explanatory power of the lagged attributes is related to both risk and mispricing in the two-factor model, but the risk e€ects explain more of the variance than mispricing. Ó 1998 Elsevier Science B.V. All rights reserved. JEL classi®cation: G12; G14 Journal of Banking & Finance 21 (1998) 1625±1665 * Corresponding author. Tel.: +1 206 543 1843; fax: +1 206 685 9392. 1 Tel.: 919-660-7768; fax: 919-661-6246; e-mail: [email protected]; web: http://www.duke.edu/ charvey. 0378-4266/97/$17.00 Ó 1997 Elsevier Science B.V. All rights reserved. PII S 0 3 7 8 4 2 6 6 ( 9 7 ) 0 0 0 4 4 7