The Information Content of Earnings and Prices: A Simultaneous Equations Approach
Posted: 4 Sep 1995
The price-earnings relation can be characterized as a system of simultaneous equations. Earnings may change for reasons that do not lead to price changes and vice versa. Hence each behaves as if it is "measured with error" for purposes of estimating the sensitivity coefficients. Equation-by- equation estimation is deficient because of underidentification and bias. Across a variety of specifications the coefficients increase dramatically in moving from OLS to 3SLS and provide less divergent estimates of the underlying parameters. The study documents that a substantial portion of the bias can be mitigated via joint estimation.
JEL Classification: M41, G14
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