Pope, P F and Wang, P (2000) Risk adjusted equity valuation and accounting betas. Working Paper. The Department of Accounting and Finance, Lancaster University.
In this paper we develop a general equity valuation model where abnormal earnings, back value, the discount factor and interest rates evolve stochastically. Focusing on the dynamics of abnormal earnings, we demonstrate the back value, abnormal earnings, "other information" and two risk adjustment terms are sufficient for valuation when pricing kernel risk is attributable to a single market factor. The risk adjustment terms depend on accounting betas reflecting the covariances between abnormal earnings and (i) the short interest rate, and (ii) the market risk factor.
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