The Many Colours of CAPE

25 Pages Posted: 10 Dec 2018

See all articles by Farouk Jivraj

Farouk Jivraj

Barclays Investment Bank; Imperial College Business School

Robert J. Shiller

Yale University - Cowles Foundation; National Bureau of Economic Research (NBER); Yale University - International Center for Finance

Date Written: October 13, 2017

Abstract

Campbell & Shiller's [1988] Cyclically-Adjusted Price to Earnings ratio (CAPE) has both its advocates and critics. Currently, the debate is on the validity of the high CAPE ratio for US stock markets in forecasting lower future returns, with CAPE currently at 31.21. We investigate the efficacy and validity of CAPE from several different perspectives. First, we run multiple-horizon predictability regressions for CAPE versus its peers and find that CAPE consistently displays economic and statistical significance far better than any of its peers. Second, we explore alternative constructions of CAPE based on other proxies for earnings motivated by the work of findings by Siegel [2016] using NIPA profits. We find that original CAPE is still best when comprehensively and fairly reviewing the other proxies, even for NIPA profits. Third, we assess how to practically use CAPE in both an asset allocation and relative valuation setting. We demonstrate a novel use of CAPE for asset allocation programmes as well as discuss relative valuation exercises for country, sector and single stock rotation.

Keywords: valuation, earnings, CAPE

JEL Classification: E3, E4, E7, G1, G4

Suggested Citation

Jivraj, Farouk and Shiller, Robert J., The Many Colours of CAPE (October 13, 2017). Available at SSRN: https://ssrn.com/abstract=3258404 or http://dx.doi.org/10.2139/ssrn.3258404

Farouk Jivraj (Contact Author)

Barclays Investment Bank ( email )

5 The North Colonnade
London, Canary Wharf E14 4BB
United Kingdom

Imperial College Business School ( email )

South Kensington campus
London, SW7 2AZ
United Kingdom

Robert J. Shiller

Yale University - Cowles Foundation ( email )

Box 208281
New Haven, CT 06520-8281
United States
203-432-3708 (Phone)
203-432-6167 (Fax)

HOME PAGE: http://www.econ.yale.edu/~shiller/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States
203-432-3708 (Phone)

Yale University - International Center for Finance ( email )

Box 208200
New Haven, CT 06520
United States
203-432-3708 (Phone)
203-432-6167 (Fax)

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