Cross-Sectional Peg Ratios, Market Equity Premium, And Macroeconomic Activity

This article explores the information content of PEG ratios (price/earnings to growth ratios) for future aggregate returns and economic fundamentals. We first establish an analytic link between PEG ratios andtime-varyingexpected returns of stocks. We then combine the link with empirical asset pricing models to extract market-wide information from cross-sectional PEG ratios. The resultant cross-section estimates of the risk premiums on stock betas serve as proxies for market-wide information. The proxies contain salient information about future market equity premiums and macroeconomic activity both in-sample and out-of-sample. Moreover, the proxies outperform aggregate PEG ratios and the cross-section beta-premium estimate based on conventional valuation ratios and retain incremental power in forecasting future market equity premiums. The results are robust to using various econometric methods for standard error adjustments.