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Nonlinear stock prices adjustment in the G7 countries

Listed author(s):
  • Georges Prat


    (EconomiX - UPOND - Université Paris Ouest Nanterre La Défense - CNRS - Centre National de la Recherche Scientifique)

  • Fredj Jawadi

This paper aims to modeling stock prices adjustment dynamics toward their fundamentals. We used the class of Switching Transition Error Correction Models (STECM) and we showed that stock prices deviations toward fundamentals could be characterized by nonlinear adjustment process with mean reversion. First, according to Anderson (1997), De Grauwe and Grimaldi (2005) and Boswijk et al.(2006), we justify these nonlinearities by the presence of heterogeneous transaction costs, behavioural heterogeneity and the interaction between shareholders expectations. After, we present STECM specification. We apply this model to describe the G7 indexes adjustment dynamics toward their fundamentals. We showed that the G7 stock indexes adjustment is smooth and nonlinearly mean-reverting and that the convergence speeds vary according to the disequilibrium extent. Finally, using two indicators proposed by Peel and Taylor (2000), we determine phases of under- and overvaluation of stock prices and measure intensity of stock prices adjustment strengths.

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Paper provided by HAL in its series Working Papers with number halshs-00172896.

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Date of creation: 18 Sep 2007
Handle: RePEc:hal:wpaper:halshs-00172896
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