SQF5: Valuation Ratios and the Long-Run Stock Market Outlook
SQF5: Valuation Ratios and the Long-Run Stock Market Outlook
A Summary
About the Book
This is a summary of the 2001 paper by John Y. Campbell and Robert J. Shiller:
John Y. Campbell and Robert J. Shiller, April 2001. “Valuation ratios and the long-run stock market outlook: An update”, NBER Working Paper Series, National Bureau of Economic Research.
The 2001 paper of Campbell and Shiller [2] is a followup of the authors’ 1998 paper [1], which was based on a testimony that the authors made before the Federal Reserve Board on December 3, 1996. Over the 1998-2001 interval, the authors also published related papers and books to expand their views, one of which is Irrational Exuberance [3].
The main thesis of the paper is that valuation ratios such as price-earning ratios and dividend-price ratios are mean-reverting and can be used to forecast future stock price changes, contrary to the simple efficient-markets models. However, a direct application of this observation is difficult, as the mean-reversion time ranges from one year to twenty years. The paper
• provided several statistical tests to support the main thesis,
• discussed the suitable explanatory variables to use,
• debunked various popular myths along the way, and
• provided results of Monte Carlo simulation to exclude the possibility of “spurious correlation”.
References
[1] John Y. Campbell and Robert J. Shiller, 1998. “Valuation ratios and the long-run stock market outlook”, The Journal of Portfolio Management, Vol. 24(2), pages 11-26.
[2] John Y. Campbell and Robert J. Shiller, April 2001. “Valuation ratios and the long-run stock market outlook: An update”, NBER Working paper Series, National Bureau of Economic Research.
[3] Robert J. Shiller. Irrational Exuberance, Princeton University Press, Princeton, New Jersey, 2000.
[4] Robert J. Shiller. Market Volatility, MIT Press, Cambridge, 1989.
About the Author
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