34 Pages Posted: 26 Jul 2003
We employ a two-regime, nonlinear model and more than a century of data to investigate the time series behavior of the S&P Composite price-dividends and price-earnings ratios. On average, the ratios display continuation fuelled by investor sentiment in bull markets but they adjust toward their long run equilibrium levels in bear markets. Impulse response functions that simulate the effect of a shock on the future evolution of the ratios exhibit the typical underreaction-overreaction time profile postulated in behavioral theories of stock returns. Our results indicate that market sentiment plays an important role in the short run but fundamentals dominate in the long run ensuring overall mean-reversion.
Keywords: Behavioral finance, underreaction-overreaction, threshold autoregression
JEL Classification: C40, G12
Suggested Citation: Suggested Citation
Fuertes, Ana-Maria and Coakley, Jerry, Continuation and Reversal in US Valuation Ratios. Essex Finance Centre Discussion Paper 04/12; EFA 2003 Annual Conference Paper No. 840; Cass Business School Research Paper. Available at SSRN: https://ssrn.com/abstract=421260 or http://dx.doi.org/10.2139/ssrn.421260
By Alex Taylor