Inferring Aggregate Market Expectations from the Cross-Section of Stock Prices

55 Pages Posted: 25 Jul 2017 Last revised: 18 May 2020

See all articles by Turan G. Bali

Turan G. Bali

Georgetown University - Robert Emmett McDonough School of Business

Craig Nichols

Syracuse University

David Weinbaum

Syracuse University

Date Written: May 17, 2020

Abstract

We introduce a new approach to predicting market returns using the cross-section of earnings and book values to explain current stock prices and extract aggregate expected returns. The proposed measure is countercyclical; it portends a significant fraction of the time-series variation in stock market returns at horizons of one month to one year, and outperforms numerous other measures, both in-sample and out-of-sample. We also find that it predicts returns in international equity markets. We use it to infer aggregate risk aversion, and find a downward trend in aggregate risk aversion and expected returns over time, leading to improvements in the information environment. We show that future aggregate earnings response coefficients increase over time, reflecting improved price informativeness.

Keywords: equity premium; future earnings response coefficients; valuation models

JEL Classification: G10, G14

Suggested Citation

Bali, Turan G. and Nichols, Craig and Weinbaum, David, Inferring Aggregate Market Expectations from the Cross-Section of Stock Prices (May 17, 2020). Available at SSRN: https://ssrn.com/abstract=3006634 or http://dx.doi.org/10.2139/ssrn.3006634

Turan G. Bali

Georgetown University - Robert Emmett McDonough School of Business ( email )

3700 O Street, NW
Washington, DC 20057
United States
(202) 687-5388 (Phone)
(202) 687-4031 (Fax)

HOME PAGE: https://sites.google.com/a/georgetown.edu/turan-bali

Craig Nichols

Syracuse University ( email )

900 S. Crouse Avenue
Syracuse, NY 13244-2130
United States

David Weinbaum (Contact Author)

Syracuse University ( email )

Syracuse, NY
United States

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