Stock Price Predictability of Financial Ratios and Macroeconomic Variables: A Regulatory Perspective

  • Received : 2013.08.07
  • Accepted : 2013.11.10
  • Published : 2013.12.31


The present study examines a set of financial ratios in predicting the up or down movements of stock prices in the context of a securities law, the Sarbanes-Oxley Act of 2002 (SOA), controlling for macroeconomic variables. Using the logistic regression with proxy betas to alleviate the incompatibility problem between the firm-specific financial ratios and macroeconomic indicators, we report evidence that financial ratios are meaningful predictors of stock price changes, which subdue the influence of macroeconomic indicators on stock returns, and more importantly that the SOA truly improves the stock price predictability of financial ratios for the markup sample. The empirical results further suggest that industry and time effects exist and that for the markdown sample the SOA actually deteriorates the predictive power of financial ratios.


Financial Ratios;Macroeconomic Variables;Sarbanes-Oxley Act;Proxy Beta;Logistic Regression


  1. Altman, E. I. (1968), Financial ratios, discriminant analysis and the prediction of corporate bankruptcy, Journal of Finance, 23(4), 589-609.
  2. Altman, E. I., Marco, G., and Varetto, F. (1994), Corporate distress diagnosis: comparisons using linear discriminant analysis and neural networks (the Italian experience), Journal of Banking and Finance, 18(3), 505-529.
  3. Berk, J. B. (1995), A critique of size-related anomalies, Review of Financial Studies, 8(2), 275-286.
  4. Bernstein, W. J. and Arnott, R. D. (2003), Earnings growth: the two percent dilution, Financial Analysts Journal, 59(5), 47-55.
  5. Brunnermeier, M. K. (2005), Information leakage and market efficiency, Review of Financial Studies, 18 (2), 417-457.
  6. Campbell, J. Y. (1987), Stock returns and the term structure, Journal of Financial Economics, 18(2), 373-399.
  7. Campbell, J. Y. (1996), Understanding risk and return, Journal of Political Economy, 104(2), 298-345.
  8. Chan, L. K., Hamao, Y., and Lakonishok, J. (1991), Fundamentals and stock returns in Japan, Journal of Finance, 46(5), 1739-1764.
  9. Chen, N. F., Roll, R., and Ross, S. A. (1986), Economic forces and the stock market, Journal of Business, 59(3), 383-403.
  10. Chen, S. S. (2009), Predicting the bear stock market: macroeconomic variables as leading indicators, Journal of Banking and Finance, 33(2), 211-223.
  11. Cohen, D. A., Dey, A., and Lys, T. Z. (2005), Trends in earnings management and informativeness of earnings announcements in the pre- and post-Sarbanes Oxley periods, Working paper, Northwestern University, Evanstron, IL.
  12. Easton, P. D. (2004), PE ratios, PEG ratios, and estimating the implied expected rate of return on equity capital, The Accounting Review, 79(1), 73-95.
  13. Einhorn, H. J. and Hogarth, R. M. (1986), Decision making under ambiguity, Journal of Business, 59(4), S225-S250.
  14. Estep, P. W. (1985), A new method for valuing common stocks, Financial Analysts Journal, 41(6), 26-33.
  15. Fairfield, P. M. (1994), P/E, P/B and the present value of future dividends, Financial Analysts Journal, 50(4), 23-31.
  16. Fama, E. F. (1990), Stock returns, expected returns, and real activity, Journal of Finance, 45(4), 1089-1108.
  17. Fama, E. F. and French, K. R. (1992), The cross-section of expected stock returns, Journal of Finance, 47 (2), 427-465.
  18. Fama, E. F. and Schwert, G. W. (1977), Asset returns and inflation, Journal of Financial Economics, 5(2), 115-146.
  19. Fuller, R. J. and Petry, G. H. (1981), Inflation, return on equity, and stock prices, Journal of Portfolio Management, 7(4), 19-25.
  20. Hamburger, M. J. and Kochin, L. A. (1972), Money and stock prices: the channels of influence, Journal of Finance, 27(2), 231-249.
  21. Ibbotson, R. G. and Chen, P. (2003), Long-run stock returns: participating in the real economy, Financial Analysts Journal, 59(1), 88-98.
  22. Jain, P. K. and Rezaee, Z. (2006), The Sarbanes-Oxley Act of 2002 and capital-market behavior: early evidence, Contemporary Accounting Research, 23(3), 629-654.
  23. Jain, P. K., Kim, J. C., amd Rezaee, Z. (2008), The Sarbanes-Oxley Act of 2002 and market liquidity, Financial Review, 43(3), 361-382.
  24. Kothari, S. P. and Shanken, J. (1997), Book-to-market, dividend yield, and expected market returns: a time-series analysis, Journal of Financial Economics, 44(2), 169-203.
  25. Kwag, S. W. and Masud, A. A. (2013), Modeling and predicting stock returns: the rule of parsimony, Working paper, Sookmyung Women's University, Seoul, Korea.
  26. Lewellen, J. (2004), Predicting returns with financial ratios, Journal of Financial Economics, 74(2), 209-235.
  27. Merton, R. C. (1973), An intertemporal capital asset pricing model, Econometrica, 41(5), 867-887.
  28. Mossman, C. E., Bell, G. G., Swartz, L. M., and Turtle, H. (1998), An empirical comparison of bankruptcy models, Financial Review, 33(2), 35-54.
  29. Petkova, R. (2006), Do the Fama-French factors proxy for innovations in predictive variables? Journal of Finance, 61(2), 581-612.
  30. Pontiff, J. and Schall, L. D. (1998), Book-to-market ratios as predictors of market returns, Journal of Financial Economics, 49(2), 141-160.
  31. Press, S. J. and Wilson, S. (1978), Choosing between logistic regression and discriminant analysis, Journal of the American Statistical Association, 73(364), 699-705.
  32. Rapach, D. and Zhou, G. (2013), Forecasting stock returns. In: Elliott, G. and Timmermann, A. (eds.), Handbook of Economic Forecasting volume 2, North-Holland, Amsterdam, the Netherlands, 327-383.
  33. Rapach, D. E., Wohar, M. E., and Rangvid, J. (2005), Macro variables and international stock return predictability, International Journal of Forecasting, 21(1), 137-166.
  34. Rosenberg, B., Reid, K., and Lanstein, R. (1985), Persuasive evidence of market inefficiency, Journal of Portfolio Management, 11(3), 9-16.
  35. Rushinek, A. and Rushinek, S. F. (1987), Using financial ratios to predict insolvency, Journal of Business Research, 15(1), 93-100.
  36. Shefrin, H. (1999), Irrational exuberance and option smiles, Financial Analysts Journal, 55(6), 91-103.
  37. Singer, Z. and You, H. (2011), The effect of Section 404 of the Sarbanes-Oxley Act on earnings quality, Journal of Accounting, Auditing and Finance, 26 (3), 556-589.
  38. Sori, Z. M. and Jalil, H. A. (2009), Financial ratios, discriminant analysis and the prediction of corporate distress, Journal of Money, Investment and Banking, 11, 5-15.
  39. Thorbecke, W. (1997), On stock market returns and monetary policy, Journal of Finance, 52(2), 635-654.
  40. Wilcox, J. W. (1984), The P/B-ROE valuation model, Financial Analysts Journal, 40(1), 58-66.
  41. Zhang, Q. J., Hopkins, P., Satchell, S., and Schwob, R. (2009), The link between macro-economic factors and style returns, Journal of Asset Management, 10(5), 338-355.