Bridge over ocean
27 February 2018 Financial Analysts Journal

Should Good Stocks Have High Prices or High Returns?

  1. Markku Kaustia
  2. Heidi Laukkanen
  3. Vesa Puttonen

Using a design involving a between-subjects experimental manipulation, this study surveyed 742 Finnish financial advisers about requiring a risk premium in one mode and about expected returns in the other mode. Company-level risk factors (e.g., leverage) caused an increased return requirement in the first mode but led to lower return expectations in the second mode. Sensitivity to the form of the question revealed an inconsistency in the advisers’ perception of risk and return. Advisers seemed to associate safe stocks with relatively lower discount rates (and thus higher valuations) but also with higher return expectations. This inconsistency may contribute to the overpricing and subsequent inferior performance of glamour stocks. Giving consistent advice is a necessary condition for providing valuable client service.

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