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Value Matters: The Long-run Behavior of Stock Index Returns

Natascia Angelini (), Giacomo Bormetti (), Stefano Marmi () and Franco Nardini ()
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Natascia Angelini: School of Economics, Management and Statistics, University of Bologna Via Angher¨¤ 22, 40127 Rimini, ITALY
Giacomo Bormetti: Department of Mathematics, University of Bologna Viale Filopanti 5, 40126 Bologna, ITALY
Stefano Marmi: Scuola Normale Superiore and C.N.R.S. UMI 3483, Laboratorio Fibonacci Piazza dei Cavalieri 7, 56126 Pisa, ITALY
Franco Nardini: Department of Mathematics, University of Bologna Viale Filopanti 5, 40126 Bologna, ITALY

Review of Economics & Finance, 2018, vol. 12, 16-28

Abstract: We present a simple dynamical model of stock index returns grounded on the ability of the Cyclically Adjusted Price Earning valuation ratio devised by Robert Shiller to predict longhorizon performances of the market. Specifically, within the model returns are driven by a fundamental term and an autoregressive component perturbed by external random disturbances. The autoregressive component arises from the agents¡¯ belief that expected returns are higher in bullish markets than in bearish ones. The fundamental value, towards which fundamentalists expect that the current price should revert, varies in time and depends on the initial averaged Price-to-Earnings ratio. We demonstrate both analytically and by means of numerical experiments that the long-run behavior of the stylized dynamics agrees with empirical evidences reported in literature.

Keywords: Fundamental and momentum strategies; Valuation ratios; CAPE; Long-run stock market returns; Value investing (search for similar items in EconPapers)
JEL-codes: D53 G12 G17 (search for similar items in EconPapers)
Date: 2018
Note: Natascia Angelini and Franco Nardini acknowledge partial support of a ¡°PRIN 2009" grant provided by MIUR(Italian Ministry of Education, University and Research) as part of the research project ¡°Local interactions and global dynamics in economics and finance: models and tools".
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