ERIM Research Seminar in Financial Management: The Book-to-Price Effect in Stock Returns: Accounting for Leverage



This paper lays out a decomposition of book-to-price (B/P) that articulates preciselyhow B/P “absorbs” leverage. The B/P ratio can be decomposed into an enterprise book-to-price(that pertains to operations and potentially reflects operating risk) and a leverage component(that reflects financing risk). The empirical analysis shows that the enterprise book-to-price ratiois positively related to subsequent stock returns but, conditional upon the enterprise book-toprice,the leverage component of B/P is negatively associated with future stock returns. Further,both enterprise book-to-price and leverage explain returns over those associated with Fama andFrench nominated factors – including the book-to-price factor – albeit negatively so for leverage.The seemingly perverse finding with respect to the leverage component of B/P survives undercontrols for size, estimated beta, return volatility, momentum, and default risk.


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Peter Roosenboom