The measure of intrinsic value and bubble: application of an improved Ohlson LIM model to Chinese A-stock

This paper, based on critically reviewing three classical valuation models, develops and empirically implements an improved Ohlson Linear Information Model (LIM) to Chinese A-stock. The new model makes three significant improvements on the initial Ohlson model: (1) it naturally extends the crucial assumption from the one order autoregression (AR(1)) to the p order autoregression (AR(p)) process; (2) it utilises the estimation of Generalised Least Squares (GLS) to eliminate the heteroskedasticity and serial correlation; and (3) introduces the relevant variables with an intrinsic value as the proxies of other information to further increase the estimation precision. The resultant valuation formula chooses three variables as the final inputs: the book value of equity, abnormal earnings and accounting income. The empirical results of the Chinese A-stock show that the share price during the period of 1995-2004 fluctuated more than its intrinsic value. The bubble still maintains the relatively high level, an Abnormal Status Bubble (ASB) characterises the whole market and the bubble size does not decrease as time elapses.