How does the market interpret analysts' long-term growth forecasts?
This paper examines the effect of inflation on stock valuations and expected long-run returns. Ex ante estimates of expected long-run returns are constructed by incorporating analysts' earnings forecasts into a variant of the Campbell-Shiller dividend-price ratio model. The negative relation between equity valuations and expected inflation is found to be the result of two effects: a rise in expected inflation coincides with both (i) lower expected real earnings growth and (ii) higher required real returns. The earnings channel mostly reflects a negative relation between expected long-term earnings growth and expected inflation. The effect of expected inflation on required (long-run) real stock returns is also substantial. A one percentage point increase in expected inflation is estimated to raise required real stock returns about one percentage point, which on average would imply a 20 percent decline in stock prices. But the inflation factor in expected real stock returns is also in long-term Treasury yields; consequently, expected inflation has little effect on the long-run equity premium.
|Date of creation:||2002|
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- Robert J. Shiller & John Y. Campbell, 1986.
"The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors,"
Cowles Foundation Discussion Papers
812, Cowles Foundation for Research in Economics, Yale University.
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- John Y. Campbell & Robert J. Shiller, 1986. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," NBER Working Papers 2100, National Bureau of Economic Research, Inc.
- John Y. Campbell & Robert J. Shiller, 1988.
"Stock Prices, Earnings and Expected Dividends,"
Cowles Foundation Discussion Papers
858, Cowles Foundation for Research in Economics, Yale University.
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- Louis K. C. Chan & Jason Karceski & Josef Lakonishok, 2003. "The Level and Persistence of Growth Rates," Journal of Finance, American Finance Association, vol. 58(2), pages 643-684, 04.
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