This dissertation empirically evaluates the relations among macroeconomic variables, systematic risk factors, and market valuation ratios. Market valuation ratios are utilized as proxies for investors’ expected or required returns. As such they are impacted both by changes in expected economic activity and by changes in perceived risk levels. To better understand the relations between market valuation ratios, economic changes, and risk factors, this dissertation undertakes three related analyses.
The first essay, “In Search of a Better Market Earnings Yield (E/P) and a Better Market Dividend Yield (D/P),” evaluates the relations between market valuation ratios and the components of interest rates, with controls for various factors. This essay demonstrates that interest rates are related to valuation ratios and that adjusting for this identified relation improves the utility of valuation ratios in forecasting market returns.
The second essay, “Systematic Risk Factors and Cash Flow Factors and Their Relations to Market Valuation Ratios as Proxies for Investors’ Required or Expected Returns,” evaluates the effects of state variables on market valuation ratios, specifically the E/P ratio and the D/P ratio. This essay identifies which macroeconomic or state variables represent or capture systematic risk factors and which macroeconomic variables affect investors’ expected returns, as measured by market valuation ratios.
The third essay, “SMB and HML: Risk Factors?”, evaluates if SMB (Small Minus Big return differentials based on the total size of market equity) and HML (High Minus Low return differentials based on book-to-market ratios) do worse relative to other equity investments in “bad” times and thus warrant a return premium as compensation for this “risk” factor. Based on this evaluation, this essay corroborates that SMB is a risk factor but provides evidence that HML is actually a contra-risk factor.
In summary, this dissertation studies the relations among risk factors, macroeconomic variables, and market valuation ratios so as to enhance the understanding of how risk factors and macroeconomic variables impact equity market valuations and equity market returns.