Working Paper: NBER ID: w8991
Authors: Lubos Pastor; Pietro Veronesi
Abstract: We develop a simple approach to valuing stocks in the presence of learning about average profitability. The market-to-book ratio (M/B) increases with uncertainty about average profitability, especially for firms that pay no dividends. M/B is predicted to decline over a firm's lifetime due to learning, with steeper decline when the firm is young. These predictions are confirmed empirically. Data also support the predictions that younger stocks and stocks that pay no dividends have more volatile returns. Firm profitability has become more volatile recently, helping explain the puzzling increase in average idiosyncratic return volatility observed over the past few decades.
Keywords: No keywords provided
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Uncertainty about average profitability (D89) | Market-to-book (MB) ratio (G32) |
| Firm age (L26) | Market-to-book (MB) ratio (G32) |
| Uncertainty about average profitability (D89) | Idiosyncratic return volatility (G17) |
| Firm age (L26) | Idiosyncratic return volatility (G17) |
| Uncertainty about average profitability (D89) | Market-to-book (MB) ratio (stronger for younger firms) (G32) |
| Learning about profitability (D22) | Market-to-book (MB) ratio (G32) |