Accounting-based valuations and market prices of equity: Case of Russian market

Abstract

This paper analyzes models of equity valuation which are based on accounting data of equity book value, net income, and residual earnings. Research is focused on the problem of validity of different analytical models which is defined by the ability of a model to produce fundamental valuations closely connected with market valuations of equity. This paper investigates versions of residual income model (RIM) under different modifications of linear information dynamics (LID). All models developed in this paper are tested on the data of Russian stock market from 2000 to 2005 year, which was booming during this period. Results showed that accounting-based valuation models have good explanation characteristics on Russian emerging market. The version of RIM which rests on assumption that investors base their expectations about future amounts of net income totally on current net incomes gives highest correlation between fundamental and market valuations of equity amounted to R-square 0,83. The version of RIM which rests on assumption that investors base their expectations about future amounts of residual earnings totally on current residual earnings gives correlation between fundamental and market valuations of equity amounted to R-square 0,78. These results could prove a hypothesis about opacity of emerging markets: on these markets investors base their expectations mainly on current information which is available and relevant for forecasting.