A Fundamental-Analysis Based Test for Speculative Prices

Abstract:     
I investigate the possibility that recent price movements include significantly larger speculative components than observed historically. My investigation is motivated by the continuing debate on recent volatility observed in stock prices. On one side of the debate, price movements are due to changes in risk and growth expectations, on the other side of the debate price movements are considered too volatile given movements in fundamentals. Using a model of fundamental value that incorporates expected risk and growth, I examine the stability of the relation between price and value over time. I observe that price and fundamental values are cointegrated over the period 1979-1993 but in the more recent 1994-2008 period there is no evidence of cointegration. I find no systematic support for alternative explanations based on expected risk or growth in not captured in fundamentals driving these results. My results provide evidence of a significant change in the long-run association between price and accounting fundamentals and imply that large speculative components in price cannot be ruled out in recent periods.

Keywords: Fundamental analysis, Speculative markets, Cointegration

JEL Classifications: G12, G14, M41

Working Paper Series