Momentum Dynamics in U.S. Valuation Ratios
35 Pages Posted: 27 Jan 2004
Date Written: January 2004
We divide the time series of aggregate valuation into bull and bear market phases to test for momentum and reversal, respectively. Our results are consistent with price-earnings and price-dividends displaying continuation by drifting upwards in bull markets irrespective of fundamentals. Such persistence can be explained by market sentiment but not within a classical framework. However the link to fundamentals is restored in bear markets where valuation ratios exhibit mean reversion toward their long run equilibrium levels and thus overall stationarity. Finally, impulse response functions indicate that shocks to the ratios typically follow an underreaction-overreaction time profile that is more pronounced in bull rather than bear markets.
Keywords: Behavioral finance, underreaction-overreaction, threshold autoregression
JEL Classification: C40, G12
Suggested Citation: Suggested Citation