Present Value Models and the Behaviour of European Financial Markets
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Present Value Models and the Behaviour of European Financial Markets Gian Maria Tomat1 Received: 2 April 2019 / Accepted: 3 September 2019 © Società Italiana degli Economisti (Italian Economic Association) 2019
Abstract According to the efficient markets hypothesis stock returns should not be predictable on the basis of information available to economic agents in any given time period. We test the hypothesis using security market panel data for the top five Eurozone countries. In static return regressions there is a positive and significant relation between stock returns at horizons of 1–12 months and the dividend/price ratio. A dynamic vector autoregression model shows, that the cross-sectional variability of actual stock prices is significantly lower than predicted. In the time dimension actual stock prices are more volatile than predicted ones, although their movements anticipate future dividend changes. We provide an interpretation of these results from the point of view of the cognitive sciences. The regression to the mean between prices and stock returns might be explained by an excess smoothness of stock prices along the cross-sectional dimension, due to the process of expectations formation. The excess sensitivity along the time dimension supports the notion of capital markets efficiency as a fundamental factor for the determination of security prices. Keywords Efficient markets · Return predictability · Volatility · Cognitive biases JEL Classification C58 · D84 · G12
1 Introduction According to the efficient markets hypothesis security prices should value information available to economic agents. The statement of the hypothesis is due to Fama (1970, 1991).
The views expressed herein are those of the author and do not necessarily involve the responsibility of the Bank of Italy.
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Gian Maria Tomat [email protected] Bank of Italy, Regional Economic Research Division, Via Venti Settembre 97/E, 00187 Rome, Italy
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G. M. Tomat
The hypothesis is usually restated as to imply, that future stock returns should not be predictable from information available to economic agents in any given period of time. In turn, the notion that stock returns are not predictable can be derived from few fundamental premises in financial theory. In the present work, we provide econometric evidence regarding the efficient markets hypothesis. We use security market panel data on prices, dividends and stock returns for the top five Eurozone countries, for the period running from February 2012 to June 2015. We examine the hypothesis from the perspective provided by two main econometric models, a static return regression model and a dynamic vector autoregression (VAR) model. In the static regression framework we compile compound stock returns at horizons of 1, 3, 6 and 12 months for each security included in the panel dataset. The efficient markets hypothesis predicts, that stock market variables in any given time period should not have predictive power for future stock returns. The static return regressions show i
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