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Stock Values and Fundamentals; Link or Irrationality?

Author

Listed:
  • Fabio Fornari

    (Banca d'Italia)

  • Marcello Pericoli

    (Banca d'Italia)

Abstract

In this paper, econometric techniques are employed to analyze the continuous and remarkable growth which has characterized international stock markets since 1995. The Campbell and Shiller dividend discount model, a dynamic version of Gordon's formula commonly employed by financial analysts to rate individual firms, is the main tool of the paper. Given the information set available at any time, the future values of the real interest rate and the expected growth of dividends are evaluated and employed as explanatory variables for the current dividend yield. The results of the econometric analysis demonstrate that current dividend yields are not in line with the expected trend in the underlying variables, for all the countries considered. A decline in the real interest rate or an increase in the expected growth of dividends, or a combination of the two, could reconcile fundamentals and current dividend yields. The assessment of whether or not such divergences are rational cannot be made safely on the basis of expectations of the fundamentals derived from the econometric scheme. These, in fact, rest on the hypothesis of rational expectations for agents utilizing the full information set of past information; of course, information related to a larger set, including survey data, or the effects of shifts in economic regimes are excluded in this setup.

Suggested Citation

  • Fabio Fornari & Marcello Pericoli, 2000. "Stock Values and Fundamentals; Link or Irrationality?," Temi di discussione (Economic working papers) 378, Bank of Italy, Economic Research and International Relations Area.
    • Handle: RePEc:bdi:wptemi:td_378_00
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    References listed on IDEAS

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    Cited by:

    1. Mr. Federico Mini & Mr. Guido De Blasio, 2000. "Seasonality and Capacity: An Application to Italy," IMF Working Papers 2000/080, International Monetary Fund.
    2. Patrick Lünnemann, 2001. "Stock market valuation of old and new economy firms," BCL working papers 2, Central Bank of Luxembourg.

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    More about this item

    Keywords

    asset pricing; dividend yield; dividend discount model;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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