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Continuation and Reversal in US Valuation Ratios
Ana-Maria Fuertes Cass Business School, City University London Jerry Coakley University of Essex - Essex Business School Essex Finance Centre Discussion Paper 04/12; EFA 2003 Annual Conference Paper No. 840 Cass Business School Research Paper Abstract: We employ a two-regime, nonlinear model and more than a century of data to investigate the time series behavior of the S&P Composite price-dividends and price-earnings ratios. On average, the ratios display continuation fuelled by investor sentiment in bull markets but they adjust toward their long run equilibrium levels in bear markets. Impulse response functions that simulate the effect of a shock on the future evolution of the ratios exhibit the typical underreaction-overreaction time profile postulated in behavioral theories of stock returns. Our results indicate that market sentiment plays an important role in the short run but fundamentals dominate in the long run ensuring overall mean-reversion.
Keywords: Behavioral finance, underreaction-overreaction, threshold autoregression JEL Classifications: C40, G12 Accepted Paper SeriesDate posted: July 26, 2003 ; Last revised: August 23, 2004Suggested CitationContact Information
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