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|کد مقاله||سال انتشار||تعداد صفحات مقاله انگلیسی||ترجمه فارسی|
|10804||2006||22 صفحه PDF||سفارش دهید|
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Publisher : Elsevier - Science Direct (الزویر - ساینس دایرکت)
Journal : Journal of Banking & Finance, Volume 30, Issue 8, August 2006, Pages 2325–2346
This paper sheds light on US stock price deviations from fundamentals by analyzing the time-series dynamics of post-1870 S&P valuation ratios. It employs a non-linear, two-regime framework that allows for different behavior over phases of the stock market cycle. Persistence in the ratios implies prolonged price deviations from fundamentals stemming from short run continuation fueled by investor sentiment during bull markets. However, the pull from fundamentals ensures that valuation ratios and prices move toward their equilibrium levels in bear markets. Impulse response functions highlight sluggish adjustment and indicate that the effects of positive shocks are more pronounced and long-lasting in bull markets. The main conclusion is that, while market sentiment plays an important transitory role, valuation ratios do mean revert and so prices reflect fundamentals in the long run.
Do stock prices always reflect fundamentals or can they display short-run and, at times, seemingly persistent deviations from their long-run equilibrium values? This question has been at the heart of a debate in financial economics ever since Shiller’s (1981) seminal study. For instance, Summers (1986) suggests that irrational fads in investor sentiment create sustained deviations of stock prices from intrinsic valuations and that rational investors might not be able to arbitrage away the mispricing because of noise trader risk. More recently, Shiller (2000) argues that the 1990s hike in prices and valuation ratios was fueled by investors’ irrational exuberance. Likewise, Anderson et al. (2003) argue that US stock prices deviated from their fundamentals in the post-World War II period and suggest a role for irrationality. Finally, Lee et al. (2002) argue that market sentiment is a priced systematic risk that is positively correlated with shifts in excess returns. Bullish changes in sentiment lead to downward revisions in volatility and higher future excess returns and vice versa for bearish changes. The issue of whether stock prices reflect fundamentals has been given new urgency by the sustained 1990s run up in prices. For example, US price–earnings (P/E) and price–dividend (P/D) series rose spectacularly during the course of that decade. The S&P (Standard and Poor’s) composite P/E ratio hit an all-time peak of 44.2 in December 1999 that was more than double its long term historical mean level. Such behavior suggests that prices can become decoupled from fundamentals for protracted periods and interpreting and theorizing such extreme movements poses a challenge for financial economics. Several rationally based explanations for the recent hike in valuation ratios have been adduced. These include a decline in the equity premium, shifts in corporate payout policies and falls in the cost of stock market participation and diversification.1 Other explanations are perhaps more plausible in a post-Enron world and, among them, factors such as noise trading, market sentiment and limits to arbitrage are prominent. This paper makes several contributions to the literature. First, taking account of the stock market cycle enables us to shed light on the deviations of prices from fundamentals. We use economic theory to motivate asymmetric behavior driven by bull and bear market phases and test for it empirically using a two-regime model.2 An interesting alternative approach is to employ models that allow for structural breaks in the ratios or the equity premium. This assumes mean reversion around a broken trend. For instance, Carlson et al. (2002) find that valuation ratios mean revert around a broken trend that shifts upwards in the early 1990s. Likewise, Manzan (2005) assumes a break in the equity premium during 1950 in analyzing the behavior of price–dividend ratios. The present paper takes a different tack. Rather than assuming similar dynamics around a broken trend equilibrium, we conjecture that valuation ratios exhibit distinct dynamics around constant long-run equilibrium levels depending on the phase of the stock market cycle. Our empirical results support contrasting bull and bear market behavior and indicate no structural break. Crucially, when we reestimate our model excluding observations from the 1990s, our long-run equilibrium valuation ratio estimates remain unchanged. In this manner our results can help to reconcile the counterintuitive finding from linear specifications suggesting a lack of mean reversion or permanent stock price deviations from fundamentals (Campbell and Shiller, 2001).3 The second contribution is that the paper facilitates tests for the presence of non-fundamental factors without having to specify an asset pricing model.4Campbell and Shiller (2001) observe that prices rather than fundamentals (dividends or earnings) do most of the adjustment in bringing the ratios back towards their long-run equilibrium levels. Thus, they argue that valuation ratios can be used to predict stock price changes and conjecture that the relationship may be non-linear.5 Moreover, since asset returns – logged price changes – are related to valuation ratios, then the celebrated theoretical models of Barberis et al., 1998, Daniel et al., 1998 and Hong and Stein, 1999 may shed some light on the behavior of the latter. These authors stress short-run departures from market efficiency in stock returns stemming from investors’ cognitive biases when updating their forecasts as Bayesian optimizers or to the interaction of noise and fundamental traders.6 We conjecture that valuation ratios also follow the underreaction–overreaction pattern that stock returns do in these models. The third contribution is that we obtain some novel results in the context of the valuation ratio literature. Our analysis reveals a significant role for non-fundamentals in explaining valuation ratio dynamics over the course of the stock market cycle. The ratios on average display continuation or underreaction in bull markets which points to the importance of market sentiment and noise trading. In other words, prices deviate from fundamentals, sometimes for protracted periods as in the 1990s. By contrast, there is significant adjustment towards long-run equilibrium in bear markets as fundamentals reassert themselves. In our framework, this implies that the ratios are mean-reverting overall despite their locally persistent bull market behavior. Impulse response functions imply that valuation ratios also exhibit the type of underreaction–overreaction time profile postulated in behavioral theories of stock returns and that the effect of innovations decays slowly. Large positive shocks to the valuation ratios in bull markets have more pronounced and long-lasting effects than similar shocks in bear markets. This lends support to the view that, during bull market episodes, fundamentals carry less weight or that deviations are more long lasting. Our key finding is that the long-run behavior of stock prices is consistent with fundamentals whilst their short-run evolution reflects unobserved behavioral factors such as market sentiment. This line of argument is similar to that of Gallagher and Taylor (2001) in their study of risky arbitrage in the US log dividend–price ratio 1926–1997 and to the one proposed by Manzan (2005) in his study of the S&P price–dividend ratio using smooth exponential autoregressions.7 Finally our results on the time-series properties of valuation ratios are germane to an extensive literature that examines stock return forecastability using regressions of stock returns on lagged valuation ratios as regressors. This is because the null distribution of typical test statistics such as the t-ratio changes dramatically if the variables are non-stationary. Standard inference approaches to ascertaining the forecasting power of valuation ratios implicitly assume that they are mean reverting. However, evidence of the latter has proven quite elusive in the empirical literature. In this sense, the present paper provides a breakthrough in that not only does it document strikingly different behavior in valuation ratios during bull and bear market phases but it also indicates that the ratios are indeed mean-reverting or that prices ultimately reflect fundamentals. The paper is organized as follows. In Section 2 we outline a theoretical framework for examining the dynamic properties of P/D and P/E ratios and present our non-linear time-series model. Section 3 discusses the hypotheses. Section 4 analyses the empirical results and a final section concludes.
نتیجه گیری انگلیسی
This paper documents asymmetries in the time evolution of valuation ratios employing a non-linear model that allows for distinct bull and bear market phases. Our analysis of a sample of monthly S&P price–dividend and price–earning ratios post-1870 yields some interesting findings. First, the ratios exhibit short-run continuation or underreaction possibly fuelled by irrational exuberance in bull market phases such as the late 1990s episode. Such dynamic behavior, namely, randomly drifting well above their long-run equilibrium level, is difficult to reconcile with risk-based, classical theories. However, it is consistent with recent behavioral contributions in financial economics that underline the role of investor sentiment and noise trading. Second, non-linear impulse response functions that simulate the evolution of the ratios following a one-off innovation indicate sluggish adjustment and that the effects of positive shocks are more pronounced in bull market phases due to the influence of market sentiment. Both of these findings help to explain the counterintuitive lack of mean reversion in the ratios that is typically inferred from standard unit root tests. Finally and reassuringly, we find evidence of reversal or significant adjustment toward equilibrium levels in bear markets. Such mean reversion in valuation ratios implies that stock prices ultimately reflect fundamentals in our framework. What do we learn from these findings? On the one hand, they vindicate Shiller’s (1981) and recent research indicating that prices can exhibit substantial short-run deviations from fundamentals due to the role of market sentiment, noise traders and limits to arbitrage. Our novel time-series framework reveals that the recognition of asymmetric dynamics over the cycle (bull and bear markets) is crucial for reconciling such apparently persistent deviations and the overall mean reversion in valuation ratios. Thus, our results not only underline the importance of noise trading and market sentiment in the short run but also corroborate that prices reflect fundamentals in the long run. Further extensions are desirable. It may be important to acknowledge this regime-sensitive behavior in forecasting models that use valuation ratios as predictors of future stock returns. This is an important issue that we intend to examine in future research. Another development of our non-linear framework would be explicitly to model the duration of bull and bear market phases as stochastic processes in order to forecast turning points in the market.