Extrapolation: Price vs. Value

Abstract

While price-based extrapolation, such as technical analysis and momentum, is well documented, the extrapolation of fundamentals has received far less attention. In this paper, we introduce a novel, data-driven approach that extrapolates multiple firm fundamentals jointly rather than in isolation, and show that it delivers both economically and statistically significant returns. Compared with analyst forecasts, our method is more broadly applicable and exhibits substantially greater economic value. We further develop a theoretical framework that decomposes the pricing impact of extrapolation into two opposing channels: a cash-flow effect, which raises prices relative to fundamentals, and a discount-rate effect, which lowers prices by increasing expected volatility. Empirically, we find that the discount-rate effect dominates, shaping the overall pricing outcome. Overall, strategies based on fundamental extrapolation significantly outperform traditional price-based extrapolation.

JEL Classification: G10, G14, G15, G30, G32, G41