Financial Analysis and the Predictability of Important Economic Events

By Ahmed Riahi-Belkaoui | Go to book overview

3

The Prediction of Systematic Risk

INTRODUCTION1

The literature of finance theory and particularly work with the capital-asset-pricing model has identified a systematic or market risk and a specific or diversifiable risk. One interesting research question has been the degree of association between the common stock systematic risk and accounting-determined risk measures. Different conceptual studies argue that differences in systematic risk between firms may be due to differences in the corporate financial decision. In other words, it is thought that corporate risk variables derived from accounting data resulting from corporate decisions may convey information about the magnitude of the systematic risk of a common stock. Empirical evidence, mainly for the U.S. market, is still inconclusive. Similar evidence for the Canadian market is either rare or suffers from serious methodological shortcomings. 2 Consequently, the purpose of this chapter is to provide some Canadian empirical evidence on the relationships between accounting-determined and market-determined measures of risk. With a knowledge of the accounting determinants of the systematic risk or beta, business managers may be able better to assess the relevance of their particular corporate decisions. Similarly, the investing public may be able better to predict any future variations in the firm’s systematic risk on the basis of published accounting numbers. Finally, a positive association between beta and accounting risk measures will provide evidence for the semi-strong efficient market hypothesis for the Canadian market in the sense that market prices reflect all publicly available information. In other words, any association will lend support to the hypothesis that accounting data reflect the events that (1) determine a security’s riskiness and (2) are also reflected in its

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