Fundamental Extrapolation and Stock Returns
54 Pages Posted:
Date Written: July 1, 2020
We explore the effects of fundamental extrapolation on stock returns. Empirically, we propose a novel approach to extrapolate firms' fundamental information and find that a strategy based on fundamental extrapolation earns a 0.80% average return per month. Theoretically, we show that fundamental extrapolation has dual effects on stock price: cash flow effect and discount rate effect. The former pushes stock price up relative to its fundamental value whereas the latter increases the representative investor's expected volatility and depresses today's stock price. Our empirical results suggest that the discount rate effect dominates the cash flow effect overall.
Keywords: Fundamental extrapolation, Return extrapolation, Volatility, Expectation
JEL Classification: G41, G14
Suggested Citation: Suggested Citation