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Forecasting Cross-Section Stock Returns using Theoretical Prices Estimated from an Econometric Model

Author

Listed:
  • George Buckley
  • Richard W P Holt

    ()

Abstract

We contribute to the debate over whether forecastable stock returns reflect an unexploited profit opportunity or rationally reflect risk differentials. We test whether agents could earn excess returns by selecting stocks which have a low market price compared to an estimate of the fundamental value obtained from an econometric model. The criterion for stock picking is one which could actually have been implemented by agents operating in real time. We show that statistically significant, and quantitatively substantial, excess returns are delivered by portfolios of stocks which are cheap relative to our estimate of fundamental value. There is no evidence that the under priced stocks are relatively risky and hence excess returns cannot easily be interpreted as an equilibrium compensation for risk.

Suggested Citation

  • George Buckley & Richard W P Holt, 1999. "Forecasting Cross-Section Stock Returns using Theoretical Prices Estimated from an Econometric Model," ESE Discussion Papers 47, Edinburgh School of Economics, University of Edinburgh.
  • Handle: RePEc:edn:esedps:47
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    File URL: http://www.econ.ed.ac.uk/papers/id47_esedps.pdf
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    References listed on IDEAS

    as
    1. Robert J. Shiller, 1984. "Stock Prices and Social Dynamics," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 15(2), pages 457-510.
    2. Christie, William G., 1990. "Dividend yield and expected returns *1: The zero-dividend puzzle," Journal of Financial Economics, Elsevier, vol. 28(1-2), pages 95-125.
    3. Bulkley, George & Harris, Richard D F, 1997. "Irrational Analysts' Expectations as a Cause of Excess Volatility in Stock Prices," Economic Journal, Royal Economic Society, vol. 107(441), pages 359-371, March.
    4. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    5. repec:hrv:faseco:30721347 is not listed on IDEAS
    6. Ball, Ray, 1978. "Anomalies in relationships between securities' yields and yield-surrogates," Journal of Financial Economics, Elsevier, vol. 6(2-3), pages 103-126.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    excess returns; trading rule; efficient markets; present value model; stock prices;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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