Fundamental Extrapolation and Stock Returns
European Finance Association 2020 Annual Meeting; American Finance Association 2022 Annual Meeting
67 Pages Posted: 16 Oct 2020 Last revised: 4 Oct 2023
Date Written: August 21, 2020
We study fundamental extrapolation based on multiple fundamental variables. Using ten leading such variables, we find that they have much stronger predictive power on stock returns than previously thought, via three pooling strategies that integrate information simultaneously. They outperform naive extrapolations using a single fundamental variable and strategies using past prices or analyst forecasts. We propose a simple equilibrium model to explain the predictability, which allows for both a cash flow effect, which pushes stock price up relative to the fundamental value, and a discount rate effect, which depresses stock price with an increased exposure on the consumption volatility.
Keywords: Fundamental Extrapolation; Return Extrapolation; Volatility; Expectation
JEL Classification: G41, G14
Suggested Citation: Suggested Citation