A General Theory of Stock Market Valuation and Return

Christophe Faugere () and Julian Van Erlach
Additional contact information
Julian Van Erlach: Nexxus Financial Technologies

Finance from EconWPA

Abstract: We show that the long-term total market and average investor's compounded stock returns are determined by GDP growth and are much less than believed because of the infeasible assumption that dividends can be fully reinvested. The long-term stock return closely approximates the return on risk-free debt, thus yielding a zero premium on a compounded per-capita basis. We demonstrate that the market earnings yield ratio (inverse P/E) is akin to a minimum nominal expected return and a direct function of inflation and a real required yield equal to long-term real GDP per capita growth, with marginal regard to risk. Our derived valuation formula is tested against the S&P 500 index and produces a 21% mean percentage tracking error, compared to 32% for the 'Fed Model' over the period 1954 - 2002.

Keywords: Required yield; Earnings yield; Equity Premium; S&P 500 Valuation; Fed Model. (search for similar items in EconPapers)
JEL-codes: G (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn, nep-fin, nep-fmk and nep-rmg
Date: 2004-03-22, Revised 2004-05-17
Note: Type of Document - pdf; pages: 32
View list of references

Downloads: (external link)
http://129.3.20.41/eps/fin/papers/0403/0403004.pdf (application/pdf)

Related works:
Working Paper: A General Theory of Stock Market Valuation and Return (2004)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpfi:0403004

Access Statistics for this paper

More papers in Finance from EconWPA
Series data maintained by EconWPA ().