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UBC Theses and Dissertations
An investigation of leverage, contrarian overextrapolation and the p/e effect Hochachka, Eugene A.
Abstract
The most common explanation for the superior returns of undervalued stocks is that market extrapolation of recent results too far into the future results in profitable opportunities for those "contrarian" investors who take advantage of the market's mistake before it corrects itself. An opposing view is that because a security's price impounds expected returns, those stocks which are riskier and will therefore be accorded high discount rates should ceteris paribus appear to be undervalued, and should thus exhibit positive excess returns over most periods. We review the evidence for both arguments and then test whether various types of leverage are priced, in the belief that leverage risk may be a factor behind the excess-returns of undervalued stocks. We find only weak evidence that leverage risk is priced, and it is clearly not priced sufficiently to be a causal factor in value-investing. We then focus our attention on a dataset in which the contrarian explanation does not hold because share price and cashflow have moved opposite to one another from previous periods, whereas for the contrarian explanation to hold price must move in the same direction as cashflows but by too much. We find the value-investing effect to be just as strong in the non-contrarian subsets as in the universe of all firms and thus conclude that the effect is not contrarian in nature but is instead consistent with market rationality, where myriad forms of risk are initially reflected in firm price and are eventually reflected in realized returns.
Item Metadata
Title |
An investigation of leverage, contrarian overextrapolation and the p/e effect
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Creator | |
Publisher |
University of British Columbia
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Date Issued |
1996
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Description |
The most common explanation for the superior returns of undervalued stocks is
that market extrapolation of recent results too far into the future results in profitable
opportunities for those "contrarian" investors who take advantage of the market's mistake
before it corrects itself. An opposing view is that because a security's price impounds
expected returns, those stocks which are riskier and will therefore be accorded high
discount rates should ceteris paribus appear to be undervalued, and should thus exhibit
positive excess returns over most periods. We review the evidence for both arguments
and then test whether various types of leverage are priced, in the belief that leverage risk
may be a factor behind the excess-returns of undervalued stocks. We find only weak
evidence that leverage risk is priced, and it is clearly not priced sufficiently to be a causal
factor in value-investing. We then focus our attention on a dataset in which the contrarian
explanation does not hold because share price and cashflow have moved opposite to one
another from previous periods, whereas for the contrarian explanation to hold price must
move in the same direction as cashflows but by too much. We find the value-investing
effect to be just as strong in the non-contrarian subsets as in the universe of all firms and
thus conclude that the effect is not contrarian in nature but is instead consistent with
market rationality, where myriad forms of risk are initially reflected in firm price and are
eventually reflected in realized returns.
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Extent |
3318737 bytes
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Genre | |
Type | |
File Format |
application/pdf
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Language |
eng
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Date Available |
2009-02-06
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Provider |
Vancouver : University of British Columbia Library
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Rights |
For non-commercial purposes only, such as research, private study and education. Additional conditions apply, see Terms of Use https://open.library.ubc.ca/terms_of_use.
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DOI |
10.14288/1.0087084
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URI | |
Degree | |
Program | |
Affiliation | |
Degree Grantor |
University of British Columbia
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Graduation Date |
1996-05
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Campus | |
Scholarly Level |
Graduate
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Aggregated Source Repository |
DSpace
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Item Media
Item Citations and Data
Rights
For non-commercial purposes only, such as research, private study and education. Additional conditions apply, see Terms of Use https://open.library.ubc.ca/terms_of_use.