FUNDAMENTAL DETERMINANTS OF NATIONAL EQUITY MARKET RETURNS - A PERSPECTIVE ON CONDITIONAL ASSET PRICING

This paper provides a global asset pricing perspective on the debate o ver the relation between predetermined attributes of common stocks, su ch as ratios of price-to-book-value, cash-flow, earnings, and other va riables to the future returns. Some argue that such variables may be u sed to find securities that are systematically undervalued by the mark et, while others argue that the measures are proxies for exposure to u nderlying economic risk factors. It is not possible to distinguish bet ween these views without explicitly modelling the relation between suc h attributes and risk factors. We present an empirical framework for a ttacking the problem at a global level, assuming integrated markets. O ur perspective pulls together the traditional academic and practitione r viewpoints on lagged attributes. We present new evidence on the rela tive importance of risk and mispricing effects, using monthly data for 21 national equity markets. We find that the cross-sectional explanat ory power of the lagged attributes is related to both risk and mispric ing in the two-factor model, but the risk effects explain more of the variance than mispricing. (C) 1998 Elsevier Science B.V. All rights re served.