What drives stock prices? Fundamentals, bubbles and investor behaviour

Abstract

Using a dynamic version of the present value model and a range of developed and Asian emerging markets, this article considers estimates of stock market prices given expectations on dividends and earnings and compares these fundamental stock prices with actual stock prices. The reported empirical results suggest that a dynamic present value model combined with differing definitions of cash flows can explain actual stock price movements for many of the sample markets. For markets where price deviations from fundamental value are statistically significant, the revealed deviations are investigated by considering types of investor behaviour which might drive such departures.

Notes

¹ See Barberis and Thaler (2003), for a survey of behavioural finance.

² See Campbell and Viceira (1999) and Chordia and Shivakumar (2002) for a discussion of the validity as to whether investors expect time-varying returns.

³ It should be noted, however, that both the dividend and earnings series cannot fully represent the ‘true’ dividend-paying ability of companies: the dividend series is essentially a ‘managed’ series, while the earnings series encounters the ‘double counting’ problem when creating the intrinsic value of asset.

⁴ While we use TB rates as the risk-free rate proxy for the US, the UK, Singapore and Malaysia markets, these rates were not available for the remaining markets. We therefore followed the approach adopted by Harvey (1994), and used the ‘most unregulated’ rates. Thus for Hong Kong, Taiwan and Indonesia, we use the 3-month interbank rate while for Japan, Korea and Thailand, money market rates are used.

⁵ See Table 7 and the discussion in Section V for the implications of cointegration with respect to the existence of rational explosive bubbles.

⁶ The CRRA for the markets of Korea and Indonesia differ according to which model (dividend or earnings) is estimated. This is a consequence of a re-adjustment of the sample period analysed for these two markets, with the adjustment due to the shorter availability of earnings data (see notes to Table 5).

⁷ Cointegration results were qualitatively similar to those reported when dividends were replaced by earnings.