Do U.S. Stock Prices Deviate from Their Fundamental Values?: Some New Evidence

Posted: 30 Oct 2001

See all articles by Dwight C. Anderson

Dwight C. Anderson

Louisiana Tech University - Department of Economics and Finance

Ali F. Darrat

Louisiana Tech University - College of Business

Maosen Zhong

University of Queensland - Business School

Multiple version iconThere are 2 versions of this paper

Abstract

We propose a new methodology to test Fama's (1991) contention that the present value model (PVM) should be augmented by time-varying expected inflation to more adequately account for actual stock price behavior. Unlike other methods, our testing approach can distinguish between the excess-price movement hypothesis of Shiller (1981) and the dividend-smoothing hypothesis of Marsh and Merton (1986). We decompose the levels (as opposed to the variances) of stock prices into their fundamental and non-fundamental elements in the context of a multivariate PVM cointegrating framework and utilize the Gonzalo and Granger (1995) procedure to formally test for the statistical significance of the non-fundamental component. Our results from monthly data for the post-WWII period do not support the inflation-augmented PVM since the non-fundamental component continues to achieve significance. This finding persists under alternative model specifications and data frequencies. The apparent failure of the traditional, rational-expectation, PVM model to adequately account for observed market behavior provides another piece of evidence supportive of Shiller's (1981) belief in some form of market "irrationality".

Keywords: Present value model, time-varying expected inflation, fundamental and non-fundamental values of stock prices, market rationality

JEL Classification: G12, G14

Suggested Citation

Anderson, Dwight C. and Darrat, Ali F. and Zhong, Maosen, Do U.S. Stock Prices Deviate from Their Fundamental Values?: Some New Evidence. Available at SSRN: https://ssrn.com/abstract=288681

Dwight C. Anderson

Louisiana Tech University - Department of Economics and Finance ( email )

Ruston, LA 71272
United States
318-257-4149 (Phone)
318-257-4253 (Fax)

Ali F. Darrat

Louisiana Tech University - College of Business ( email )

Department of Economics & Finance
P.O. Box 10318
Ruston, LA 71272
United States
318-257-3874 (Phone)
318-257-4253 (Fax)

Maosen Zhong (Contact Author)

University of Queensland - Business School ( email )

Brisbane, Queensland 4072
Australia

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