Solving the Price-Earnings Puzzle
University of Technology, Sydney - UTS Business School, Finance Discipline Group; Financial Research Network (FIRN)
The University of Sydney Business School
UTS Working Paper No. 116
Accounting and finance professionals have empirically known that in the long run stock prices are roughly proportional to earnings. However, econometric testing could not been able to verify this expected contribution of earnings to stock prices, thus formed the price-earnings (PE) puzzle in the accounting literature. This paper seeks to solve this puzzle by allowing the earnings response coefficient to be a variable instead of a constant, and shows that the PE puzzle turns out to be a phenomenon of type I spurious regression in econometrics.
Number of Pages in PDF File: 13
Keywords: price (returns)-earnings relation, earnings response coefficient, type I spurious regression
JEL Classification: C22, G12, M41working papers series
Date posted: February 2, 2006
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