Proceedings

to-unit root properties. Thus, there can appear uninformative inferences on predictive
relations (Valkanov, 2003; Lewellen, 2004).
Another observation underlines the fact that the process by which the
contemporaneous stock price reflects value relevant information (both accounting and
non-accounting) remains unchanged over time. In our opinion, this is a critical
hypothesis, since it is equivalent with the absence of any learning process in the
investors’ decisions, process that would be able to guide the adjustments in the
construction and management of financial assets’ portfolios. If this is presumed, then
it is possible to take into account more sophisticated inter-linkages between the
evolution of stocks and the financial performance of their issuers. A direct testable
consequence for such inter-linkages could be the manifestation of non-linear
connections between prices’ dynamics and the content of the financial statements. In
this sense, there are recent empirical evidence showing convexity in the relationship
between prices and accounting information. Empirical tests, although exploratory,
provide further evidence of a nonlinear relation between stock price and accounting
measures of earnings and book value (see, for instance, Riffe and Thompson, 1998).
In the mean time, it is not completely clear how much predictive power can be
attributed to financial ratios.
Summers (1986), Fama and French (1988), and Campbell and Shiller (1989, 2005)
suggest a simple theory of slow mean reversion to explain the predictive power. That
is, stock prices cannot drift too far from their fundamentals (e.g., dividend, earnings,
and book value) in the long run. The theory of slow mean reversion requires financial
ratios to be stationary.
As Chang et al. (2008) notes “The phenomenon of the mean-reversion discussed from
the literature explore whether the stock price followed random walk. If the stock
prices violate the trend of random walk, one possibility is the stock prices followed
mean-reversion process. If the stock prices followed mean reversion in the long-run,
the price movements should be predictable from the movements in firm fundamental
values. In this sense, determining whether stock prices are mean-reversion is a very
important issue for investors. Consequently, to analysis equity fundamentals, what is
important is to verify whether the stock price moves with its firm’s fundamental”.
Lamont (1998) argues that fundamentals predict returns in the short run, while prices
predict returns in the long run. Supplementary, the prediction relation between returns
and financial ratios appears to suffer from structural instability over time. Especially,
in the late 1990s, the prediction relation seems not robust (see, Goyal and Welch,
2003; Paye and Timmermann, 2006; Lettau and Van Nieuwerburgh, 2008).
Also, it should be considered the argument advanced by Lettau and Van
Nieuwerburgh (2008) who are suggesting that the puzzling empirical patterns in
return prediction are caused by the changes in the steady-state mean of financial ratios
and are estimating regime-switching models for the steady-state mean of financial
ratios.
Guan (2010) noticed that firm financial ratios can help identify stocks that outperform
other stocks during recessions, even after controlling for firm characteristics such as
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