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Equity Prices and Fundamentals: a DDM-APT Mixed Approach

Fredj Jawadi () and Georges Prat ()

No 2015-16, EconomiX Working Papers from University of Paris Nanterre, EconomiX

Abstract: This paper focuses on the linkages between equity prices and fundamentals for 27 individual shares from the French stock price index (CAC40). To assess fundamental value, the traditional Dividend Discount Model (DDM) equities’ valuation principle is coupled with the Portfolio Choice Theory based on the Arbitrage Pricing Theory (APT). This yields a general equity valuation relationship for which the APT determines the long-term risk premium included in the DDM. Interestingly, restrictions are less significant than in the usual approaches since the number of risk premium factors is not limited a priori by the theory. Accordingly, our empirical results point to two major findings. On the one hand, while results in the literature based on the DDM showed that fundamental value dynamics are very smooth with respect to stock price indices, our DDM-APT model reproduces both trends and major share price fluctuations. On the other hand, a simple linear Error Correction Model (ECM) highlighted a mean-reversion process of equity prices towards their fundamental values.

Keywords: Stock valuation; equity risk premium; stock price adjustment. (search for similar items in EconPapers)
JEL-codes: G11 G12 C58 C22 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn
Date: 2015
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Related works:
Journal Article: Equity prices and fundamentals: a DDM–APT mixed approach (2017) Downloads
Working Paper: Equity Prices and Fundamentals: a DDM-APT Mixed Approach (2015) Downloads
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