Research On Value Premium In China's Stock Market

Financial anomalies are the hot points in recent financial empirical researches. There are many papers about financial anomalies, especially BM ratio. In domestic academic field, many papers have proved that there exists value premium in Shanghai and Shenzhen stock markets. Firms with higher BM ratio will earn higher returns in the future. Now the explanations for BM effect are still controversial in domestic researches. In this paper I want to analyze the potential reasons for value premium by using Daniel and Titman (2006)'s decomposition method.Book-to-Market ratio is a calculated factor; it not only represents past accounting information, but also reflects the future growth information which cannot be contained in the past accounting measures. In this paper, I first decomposed the BM ratio into three components. The first and second parts are the information about the past accounting measures, which I called tangible information. The third part is about the future growth or cash flow or something that orthogonal to the firm's past accounting information, which I called intangible information. Then in the empirical tests I analyzed which type of information would forecast the stock returns, and then we could see the real potential reason about value premium. In the last, I analyzed the relationship between intangible information and FF three-factor model.The empirical results showed that intangible return and future stock return was negatively related, but tangible return was not significant in statistics. This result was still true after controlling stock market capitalization. The portfolio excess return constructed by realized intangible return could not be explained by FF-three factors model, the rational pricing model was rejected. So I use behavioral explanation to explain the BM effect: the BM effect is only because market overreaction to intangible information.By the decomposition, the information contained in the BM variable was classified into two parts. In this way, we can see the real reason for Book-to-Market ratio effect. This paper presents a new view about value premium and provides an empirical evidence for irrational pricing theory.