B/M Ratio Essay -- Research Analysis

We can see from regression I of Panel A and B that B/M is highly significant relative to the future returns, which are consistent with the B/M effect theory. The B/M effect for NOA/P^NOAï ¹ ¤1 data also cannot be rejected for the ambiguous t-statistic. Similarly, the enterprise B/M ratio is confirmed by regression II. The testing results for one factor model of financial leverage (ND/M) presents that the financial leverage is not significantly relative to future returns, or even negatively relative to future returns. It is an anomalous phenomenon that the leverage (financial risk) reduces the expected returns, but it may be explained by the negative association between leverage and operating risk. Actually, these results are also consistent with also correlation analysis in Table 2. When NOA/P^NOA≠§1, leverage is positively and insignificantly relative to the NOA/P^NOA. However, when NOA/P^NOAï ¹ ¤1, leverage is negatively relative to NOA/P^NOA. Regression V shows the leverage coefficient under controlling for operating risk (enterprise B/M ratio). For full sample tests, the coefficient is insignificant which means we cannot get any reliable conclusions from this result. And for NOA/P^NOA ≠§1, the coefficient is insignificantly positive, for NOA/P^NOAï ¹ ¤1, the coefficient is significantly negative. If we split the ND/M ratio into financial liabilities/market value and financial assets/ market value like in regression VII, FA/P coefficients are significantly positive in all of three panels, but the FL/P negatively or insignificantly relative to future returns. It indicates that the high future return premium is awarded for the high operating risk rather than financial risk. As the financial leverage is insignificant in some regressions, we u... ...returns, and this association is even insignificant for most NOA/P^NOA portfolios. The only exception is in the highest two NOA/P^NOA portfolios, highest ND/M portfolios give higher returns than lowest ND/M portfolios. Similarly with US evidence, the findings in UK evidence suggest that the UK FTSE 350 stock returns are inconsistent with PRT’s equation 2. In Panel B of table 4, we use similar methods with Panel A to spilt the year-firm observations into 10 portfolios, and sort these observations into five groups by B/M ratio rather than leverage ratio. According to PRT equation 1, if NOA/P^NOA >1, a higher leverage ratio will lead to a higher B/M ratio; if (NOA )/P^NOA 1, a higher return the higher B/M ratio.