Solving the Price-Earnings Puzzle

Carl Chiarella and Shenhuai Gao
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Shenhuai Gao: Discipline of Economics, University of Sydney

No 116, Working Paper Series from Finance Discipline Group, UTS Business School, University of Technology, Sydney

Abstract: Accounting and finance professionals have empirically known that in the long run stock prices are roughly proportional to earnings. However, econometric testing could not been able to verify this expected contribution of earnings to stock prices, thus formed the price-earnings (PE) puzzle in the accounting literature. This paper seeks to solve this puzzle by allowing the earnings response coefficient to be a variable instead of a constant, and shows that the PE puzzle turns out to be a phenomenon of type I spurious regression in econometrics.

Keywords: price (return)-earnings relation; earnings response coefficient; type I spurious regresssion (search for similar items in EconPapers)
JEL-codes: C22 G12 M41 (search for similar items in EconPapers)
Date: 2002-04-01
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Citations: View citations in EconPapers (3)

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