The fair value of the U.S. stock market: A structural VECM approach

Martin Charron

Working Papers-Department of Finance Canada from Department of Finance Canada

Abstract: The goal of this paper is to disentangle permanent and transitory components of U.S stock prices, using the SVECM methodology of King, Plosser, Stock and Watson (1991). This methodology uses the information contained in the cointegration vectors to identify the structural permanent shocks in the model. Since the estimated long run impact of these shocks on stock prices constitutes the stock market permanent component, the model can also be used to estimate the stock market "fair" value. Alternatively, the transitory component of the real stock price gives an indication of the degree of overvaluation (or undervaluation) of the stock market. Our main results are that most of the rise in real stock prices over the 1995-1999 period was associated with the increase in real corporate profits and the reduction in inflation.

Le but de ce travail est d’identifier les composantes permanente et transitoire constituant le prix des titres boursiers américains, à l’aide de la méthodologie SVECM développée par King, Plosser, Stock et Watson (1991). Cette méthodologie utilise l’information contenue dans les vecteurs de cointégration pour identifier les chocs structurels permanents du modèle. Puisque l’impact estimé de ces chocs à long terme sur les prix boursiers constitue la composante permanente du marché boursier, le modèle peut aussi être utilisé pour estimer le « juste » prix des valeurs boursières. Alternativement, la composante transitoire identifiée donne une indication du degré de sur-évaluation (ou de sous-évaluation) du marché boursier. Notre principal résultat est que la hausse du marché boursier américain au cours de la période 1995-1999 s’explique principalement par la hausse des profits des entreprises et la réduction de l’inflation.

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