A Theoretical and Empirical Analysis of the Relationship Between Market and Book Values

Practitioners and academics often use book values instead of market values when market data is not available. This is appropriate only if market values and book values are related. In this paper a theoretical model of the relationship between market values and book values is developed and this model is tested directly using time-series analysis. The results obtained suggest that although market values and book values may differ in the short run there is a linear relationship between them in the long run. However a simple dynamic forecast of the model suggests that it could take more than 10 years for the two series to approach each other after a shock to one or both of the series. That is, the long run may be too long to be of any practical use.