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A Generalized Earnings-Based Stock Valuation Model

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  • MING DONG
  • DAVID HIRSHLEIFER

Abstract

This paper provides a model for valuing stocks that takes into account the stochastic processes for earnings and interest rates. Our analysis differs from past research of this type in being applicable to stocks that have a positive probability of zero or negative earnings. By avoiding the singularity at the zero point, our earnings-based pricing model achieves improved pricing performance. The out-of-sample pricing performance of the generalized earnings valuation model (GEVM) and the Bakshi and Chen pricing model are compared on four stocks and two indices. The generalized model has smaller pricing errors and greater parameter stability. Furthermore, deviations between market and model prices tend to be mean-reverting using the GEVM model, suggesting that the model may be able to identify stock market misvaluation. Copyright Blackwell Publishing Ltd and The University of Manchester, 2005.

Suggested Citation

  • Ming Dong & David Hirshleifer, 2005. "A Generalized Earnings-Based Stock Valuation Model," Manchester School, University of Manchester, vol. 73(s1), pages 1-31, September.
  • Handle: RePEc:bla:manchs:v:73:y:2005:i:s1:p:1-31
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    References listed on IDEAS

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    1. Malcolm Baker & Richard S. Ruback & Jeffrey Wurgler, 2004. "Behavioral Corporate Finance: A Survey," NBER Working Papers 10863, National Bureau of Economic Research, Inc.
    2. Brennan, Michael J. & Schwartz, Eduardo S., 1979. "A continuous time approach to the pricing of bonds," Journal of Banking & Finance, Elsevier, vol. 3(2), pages 133-155, July.
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    5. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
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    8. Zhiwu Chen & Ming Dong, 2001. "Stock Valuation and Investment Strategies," Yale School of Management Working Papers ysm212, Yale School of Management, revised 01 Oct 2001.
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    Cited by:

    1. Bergeron, Claude, 2013. "Dividend sensitivity to economic factors, stock valuation, and long-run risk," Finance Research Letters, Elsevier, vol. 10(4), pages 184-195.

    More about this item

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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