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Modelling the Value of the S&P 500 - A System Dynamics Perspective

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Abstract

This paper seeks to model the adjustment process in the stock market by a continuous time state space model focusing on input-out relations. The value of the S&P 500 is generated as the output of the model with earnings and the interest rate as input. The model is found to fit the data well, and indicates that the stock price dynamics can be considered as a price-following-value process. The value determines the time varying trend of price, and random buy-sell pressure drives price fluctuations about value. The 1987 stock price bubble shows up clearly as a gap between price and value.

Suggested Citation

  • Carl Chiarella & Shenhuai Gao, 2002. "Modelling the Value of the S&P 500 - A System Dynamics Perspective," Working Paper Series 115, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  • Handle: RePEc:uts:wpaper:115
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    File URL: http://www.finance.uts.edu.au/research/wpapers/wp115.pdf
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    References listed on IDEAS

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    1. Andrew W. Lo, A. Craig MacKinlay, 1988. "Stock Market Prices do not Follow Random Walks: Evidence from a Simple Specification Test," Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 41-66.
    2. Chiang, Raymond & Davidson, Ian & Okunev, John, 1997. "Some further theoretical and empirical implications regarding the relationship between earnings, dividends and stock prices," Journal of Banking & Finance, Elsevier, vol. 21(1), pages 17-35, January.
    3. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-436, June.
    4. Merton H. Miller & Franco Modigliani, 1961. "Dividend Policy, Growth, and the Valuation of Shares," The Journal of Business, University of Chicago Press, vol. 34, pages 411-411.
    5. Carl Chiarella & Shenhuai Gao, 2002. "Solving the Price-Earnings Puzzle," Working Paper Series 116, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
    6. Charles M. C. Lee & James Myers & Bhaskaran Swaminathan, 1999. "What is the Intrinsic Value of the Dow?," Journal of Finance, American Finance Association, vol. 54(5), pages 1693-1741, October.
    7. Carl Chiarella & Shenhuai Gao, 2002. "Type I Spurious Regression in Econometrics," Working Paper Series 114, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
    8. Carl Chiarella, 1992. "The Dynamics of Speculative Behaviour," Working Paper Series 13, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
    9. Carl Chiarella & Shenhuai Gao, 2004. "Continuous Time Model Estimation," Working Paper Series 138, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
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    Cited by:

    1. Carl Chiarella & Shenhuai Gao, 2002. "Solving the Price-Earnings Puzzle," Working Paper Series 116, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
    2. Carl Chiarella & Shenhuai Gao, 2004. "Continuous Time Model Estimation," Working Paper Series 138, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
    3. Shamsuddin, Abul F. M. & Hillier, John R., 2004. "Fundamental determinants of the Australian price-earnings multiple," Pacific-Basin Finance Journal, Elsevier, vol. 12(5), pages 565-576, November.

    More about this item

    Keywords

    stock price; intrinsic value; stock price bubble; adjustment process;

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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