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Value Matters: The Long-run Behavior of Stock Index Returns

Author

Listed:
  • Natascia Angelini

    (School of Economics, Management and Statistics, University of Bologna Via Angher¨¤ 22, 40127 Rimini, ITALY)

  • Giacomo Bormetti

    (Department of Mathematics, University of Bologna Viale Filopanti 5, 40126 Bologna, ITALY)

  • Stefano Marmi

    (Scuola Normale Superiore and C.N.R.S. UMI 3483, Laboratorio Fibonacci Piazza dei Cavalieri 7, 56126 Pisa, ITALY)

  • Franco Nardini

    (Department of Mathematics, University of Bologna Viale Filopanti 5, 40126 Bologna, ITALY)

Abstract

We present a simple dynamical model of stock index returns grounded on the ability of the Cyclically Adjusted Price Earning valuation ratio devised by Robert Shiller to predict longhorizon performances of the market. Specifically, within the model returns are driven by a fundamental term and an autoregressive component perturbed by external random disturbances. The autoregressive component arises from the agents¡¯ belief that expected returns are higher in bullish markets than in bearish ones. The fundamental value, towards which fundamentalists expect that the current price should revert, varies in time and depends on the initial averaged Price-to-Earnings ratio. We demonstrate both analytically and by means of numerical experiments that the long-run behavior of the stylized dynamics agrees with empirical evidences reported in literature.

Suggested Citation

  • Natascia Angelini & Giacomo Bormetti & Stefano Marmi & Franco Nardini, 2018. "Value Matters: The Long-run Behavior of Stock Index Returns," Review of Economics & Finance, Better Advances Press, Canada, vol. 12, pages 16-28, May.
    • Handle: RePEc:bap:journl:180202
    Note: Natascia Angelini and Franco Nardini acknowledge partial support of a ¡°PRIN 2009" grant provided by MIUR(Italian Ministry of Education, University and Research) as part of the research project ¡°Local interactions and global dynamics in economics and finance: models and tools".
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    References listed on IDEAS

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    1. Amihud, Yakov & Hurvich, Clifford M., 2004. "Predictive Regressions: A Reduced-Bias Estimation Method," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 39(4), pages 813-841, December.
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    More about this item

    Keywords

    Fundamental and momentum strategies; Valuation ratios; CAPE; Long-run stock market returns; Value investing;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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