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The information content of the Bond-Equity Yield Ratio: better than a random walk?

Listed author(s):
  • GIOT, Pierre
  • PETITJEAN, Mikael

Since the 1990's run up in stock prices and subsequent crashes, the financial community has taken a dim view of the traditional valuation ratios and has instead turned its attention to a new valuation ratio: the Bond-Equity Yield Ratio (BEYR). In this paper we provide the first comprehensive, both in-sample and out-of-sample, statistical assessment of the fundamental short-term reversion dynamics of the BEYR towards its long-term mean. Using cointegrated VAR models, we show that the BEYR can depart from its longterm relationship for an extended period of time before reversion process finally brings it back to equilibrium. The out-of-sample forecasting analysis, based on both equally and superior predictive ability tests, shows that the cointegrated VAR model does not perform better than a naive random walk. As such, we cast doubt on the ability of the BEYR to predict monthly stock return.

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Paper provided by Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers with number 2006089.

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Date of creation: 00 Oct 2006
Handle: RePEc:cor:louvco:2006089
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