The Convergence of Prices to Fundamental Values

Previous study shows that value-to-price ratios (V/P) predict future stock returns. This empirical regularity is consistent with the notion that stock prices converge to fundamental values over time for mispriced securities. However, the existing evidence on price convergence is indirect and incomplete. This book examines the extent to which price convergence to fundamental value explains the success of V/P trading strategy. In addition, evidence is provided to show the effects of analyst forecast, price momentum and earnings announcement in the convergence process. An ex ante model is developed to predict what types of stocks are likely to exhibit the tendency of price convergence to fundamental value. The analysis should help shed some light on the debate on capital market efficiency, and should be useful to anyone who may be interested in equity valuation, fundamental analysis and stock trading strategies.