Up the Stairs, Down the Elevator: Valuation Ratios and Shape Predictability in the Distribution of Stock Returns
While a large literature on return predictability has shown a link between valuation levels and expected rates of returns, we document a robust link between valuation levels and the shape of the distribution of cumulative (up to 24 months) total returns. Return distributions become more asymmetric and negatively skewed when valuation levels are high. In contrast, they are roughly symmetric when valuation levels are low. These results shed some light on how equity prices regress back to their means conditional on valuation levels and have important practical implications for risk measurement and asset management.
Link to SSRN