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Expectations of Fundamentals and Stock Market Puzzles

Pedro Bordalo, Nicola Gennaioli (), Rafael La Porta () and Andrei Shleifer

No 27283, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We revisit several leading puzzles about the aggregate stock market by incorporating into a standard dividend discount model survey expectations of earnings of S&P 500 firms. Using survey expectations, while keeping discount rates constant, explains a significant part of “excess” stock price volatility, price-earnings ratio variation, and return predictability. The evidence is consistent with a mechanism in which good news about fundamentals leads to excessively optimistic forecasts of earnings, especially at long horizons, which inflate stock prices and lead to subsequent low returns. Relaxing rational expectations of fundamentals in a standard asset pricing model accounts for stock market anomalies in a parsimonious way.

JEL-codes: G02 G12 G4 (search for similar items in EconPapers)
Date: 2020-05
New Economics Papers: this item is included in nep-fmk and nep-ore
Note: AP
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