Review of Accounting Studies

, Volume 6, Issue 4, pp 397–425 | Cite as

A General Affine Earnings Valuation Model

  • Andrew Ang
  • Jun Liu
Article

Abstract

We introduce a methodology, with two applications, that incorporates stochastic interest rates, heteroskedasticity and risk aversion into the residual income model. In the first application, goodwill is an affine (constant plus linear term) function where the constant and linear coefficients are time-varying. Homoskedastic risk gives rise to a constant risk premium, while heteroskedastic risk gives rise to linear state-dependent risk premiums. In the second application, we present a class of models where a non-linear function for the price-to-book ratio can be derived. We show how interest rates, risk, profitability and growth affect the price-to-book ratio.

stock valuation earnings residual income model asset-pricing affine model linear information dynamics 

Preview

Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.

References

  1. Ang, A. and J. Liu. (1998). “A Generalized Earnings Model of Stock Valuation.” Stanford Research Paper 1491.Google Scholar
  2. Bakshi, G. and Z. Chen. (2001). “Stock Valuation in Dynamic Economies.” Working Paper, Yale University.Google Scholar
  3. Bekaert, G. and S. Grenadier. (2001). “Stock and Bond Pricing in an Affine Economy.” Working Paper, Columbia University.Google Scholar
  4. Black, F. and M. Scholes. (1973). “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy 81, 637-654.Google Scholar
  5. Cox, J. S., J. Ingersoll and S. Ross. (1985). “A Theory of the Term Structure of Interest Rates.” Econometrica 53, 385-408.Google Scholar
  6. Duffie, D. and R. Kan. (1996). “A Yield-Factor Model of Interest Rates.” Mathematical Finance 6:4, 379-406.Google Scholar
  7. Duffie, D. and J. Liu. (2001). “Floating-Fixed Credit Spreads.” Financial Analysts Journal 57:3, 76-87.Google Scholar
  8. Fama, E. F. and K. R. French. (2000). “Forecasting Profitability and Earnings.” Journal of Business 73:2, 161-175.Google Scholar
  9. Feltham, G. A. and J. A. Ohlson. (1995). “Valuation and Clean Surplus Accounting for Operating and Financial Activities.” Contemporary Accounting Research 11:2, 689-731.Google Scholar
  10. Feltham, G. A. and J. A. Ohlson. (1999). “Residual Earnings Valuation with Risk and Stochastic Interest Rates.” The Accounting Review 74:2, 165-183.Google Scholar
  11. Harrison, J. M. and D. M. Kreps. (1979). “Martingales and Arbitrage in Multiperiod Securities Markets.” Journal of Economic Theory 2:3, 381-408.Google Scholar
  12. Lucas, R. (1978). “Asset Prices in an Exchange Economy.” Econometrica 46:6, 1429-1445.Google Scholar
  13. Miller, M. and F. Modigliani. (1961). “Dividend Policy, Growth and the Valuation of Shares.” Journal of Business 34:4, 411-433.Google Scholar
  14. Nissim, D. and S. H. Penman. (2000). “The Empirical Relationship Between Interest Rates and Accounting Rates of Return.” Working Paper, Columbia University.Google Scholar
  15. Ohlson, J. A. (1990). “A Synthesis of Security Valuation Theory and the Role of Dividends, Cash Flows and Earnings.” Journal of Contemporary Accounting Research 6:2, 648-676.Google Scholar
  16. Ohlson, J. A. (1995). “Earnings, Book Values and Dividends in Equity Valuation.” Journal of Contemporary Accounting Research 11:2, 661-687.Google Scholar
  17. Ou, J. A. and S. H. Penman. (1989). “Accounting Measurement, Price-Earnings Ratio and the Information Content of Security Prices.” Journal of Accounting Research 27:0, 111-144.Google Scholar
  18. Penman, S. H. (1991). “An Evaluation of Accounting Rate-of-Return.” Journal of Accounting, Auditing and Finance 6:2, 233-255.Google Scholar
  19. Zhang, G. (1998). “Accounting Information, Capital Investment Decisions, and Equity Valuation: Theory and Empirical Implications.” Working Paper, Hong Kong University of Science and Technology.Google Scholar

Copyright information

© Kluwer Academic Publishers 2001

Authors and Affiliations

  • Andrew Ang
    • 1
  • Jun Liu
    • 2
  1. 1.Columbia University and NBERNew York
  2. 2.Anderson School C509UCLAUCLA

Personalised recommendations