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• W1545422668 abstract "INTRODUCTION Stock market crashes shake the financial markets stability around the globe at each occurrence. The aftermath of these negative swings is devastating on investors. The stock market crash of 2000 destroyed more than $8 trillion of investors' wealth, for example (Nofsinger, 2001), while in 2008 the stock market lost more than 50% of its value with dramatic repercussions on the economy in general and on the investors in particular. The purpose of this study is to identify a reliable measure of risk during periods of negative price swings. The study tests the reliability of one of the most widely used measures of risk, beta (B), during such negative price swings and tests the predictive power of price-earnings ratio as an alternative to beta in measuring risk. LITERATURE REVIEW Researchers do not agree on the factors that causing these stock market downturns. Sornette (2003) argued that the major cause of the market crashes was the exaggerated expectations of future earnings by investors who overlooked the economic fundamentals--people invested in companies that promised high returns but whose financials were unable to meet these promises. Ofek and Richardson (2002), in discussing the stock crash market of the year 2000, discussed the wide gap between price and their fundamental values in the period that preceded the 2000 market freefall. Zuckerman and Rao (2004) related the market crash of 2000 to the main features of trading in Technology stocks early in the 1990s, during which investors and stock traders were unable to explain the wide fluctuations in prices of Internet stock, and failed to predict its implications on the broader markets. Baigent and Massaro (2005), meanwhile, in their analysis of the 1987 market crash concluded that portfolio insurance was the most plausible explanation for the rapid downturn. They discussed the important role of derivative securities in contributing to the escalation of market capitalizations through the first nine months of 1987. The capital pricing asset pricing model (CAPM) remains the most dominant theory in the investments literature, relating beta as a measure of relevant risk to the return from a financial asset. There is documented research, however, pointing to the use of financial measures as an explanatory variable in stock markets return analysis. Fama and French (1992), for example, showed evidence of the relationship between return and size, price-to-book ratio, and prior returns. The pointed to the incremental return with a risk component not explained in the assets pricing model. Aras and Yilmaz (2008) used price-earnings, dividend yield and market-to-book ratio to predict returns in emerging markets. Ang and Bekaert (2003) discussed the reliability of using price-earnings ratio to predict future dividend growth. In the same direction, Lamont (1998) argued that price-earnings ratio has independent predictive power for excess returns. Lewellen (2001) similarly highlighted the predictive power of financial ratios in determining returns. Conventionally, however, beta remains the dominant measure of relevant systematic risk. This paper tests the reliability of using beta in predicting riskiness of investment in financial assets: [H.sub.0]: Beta is a reliable measure of risk. Additionally, we examine the use of price-earnings ratio as an alternative measure: [H.sub.0]: Price-Earning ratio (P/E) is a predictive measure of risk. RESEARCH MODEL The purpose of the study is to examine the reliability of beta as a measure of risk by predicting the stock price movement during negative price swings and to test the predictive power of a price-earnings ratio as a measure of risk during the same period. The procedure used is to identify two groups of stocks (dependent variable). The first group consists of stocks that observed a sharp negative price movement during a crash period (Y = 0), and the second group are those stocks that did not have a negative sharp price movement during the same crash period (Y = 1). …" @default.
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• W1545422668 date "2010-04-01" @default.
• W1545422668 modified "2023-09-28" @default.
• W1545422668 title "Risk Prediction Capabilities of P/e during Market Downturns" @default.
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