The Volatility of the Pe Ratio and its Components: A Contrast of Japanese and U.S. Markets

This paper extends previous research by reexamining the difference in cross‐sectional variability of Japanese and U.S. price‐to‐earnings (PE) ratios. A simple model is developed to decompose the variance of the PE ratio into three components: the variance of the price‐to‐book (PB) ratio, the variance of the book‐to‐earnings (BE) ratio and the covariance of the PB and BE ratios. We analyze the behavior of the cross‐sectional variability of the PE ratio and its components and compare the behavior of these ratios across the U.S. and Japanese markets. We find that the cross‐sectional variability of the PE ratio in the Japanese market is consistently lower than that of the PB ratio and the converse is true for the U.S. market. The cross‐sectional variability of PE ratios in Japan is lower than that in the U.S. and the converse is true for the PB ratio. Our results are inconsistent with those reported by Bildersee et al. and indicate that the main factor causing the differences between the cross‐sectional variability of PE ratios and PB ratios is the high negative covariance of the PB and BE ratios.