Structural breaks in financial ratios: evidence for nine international markets
Financial ratios have recently reached unprecedented levels and despite price falls remain at ahistoric levels. This is at odds with the theoretical present value model. Whilst, several researchers have attempted to reconcile theory and data using fractional integration and nonlinear techniques, an alternate view is that such ratios do not revert to a single point but exhibit a time-variation in their level. This article, tests for and supports, the belief that financial ratios exhibit structural breaks, or level shifts, through time. As such, the present value model does not hold exactly, but needs to accommodate such shifts. This may also explain apparent contradictory findings in long-horizon return predictability regressions performed over different sample periods.
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