IDEAS home Printed from https://ideas.repec.org/a/gam/jjrfmx/v16y2023i9p410-d1239742.html
   My bibliography  Save this article

Why the High Values for the CAPE Ratio in Recent Years Might Be Justified

Author

Listed:
  • Leo H. Chan

    (Woodbury School of Business, Utah Valley University, Orem, UT 84058, USA)

Abstract

In this paper, I propose a tracking error approach using the P/E ratio equation to approximate the CAPE Ratio. After accounting for the recent structural changes in the composition and valuation of the S&P 500 index, along with a persistently low interest rate environment over the last three decades, I show that the average CAPE Ratio had increases over time. Relying solely on historical CAPE averages to forecast equity returns may therefore prove unreliable. The findings in this paper indicate that investors should incorporate multiple factors, including required return and expected earnings growth, when forming capital allocation decisions across asset classes. Rotating out of the equity market simply because the CAPE Ratio shows that the equity market is too expensive might not produce the desire outcome investors hope for.

Suggested Citation

  • Leo H. Chan, 2023. "Why the High Values for the CAPE Ratio in Recent Years Might Be Justified," JRFM, MDPI, vol. 16(9), pages 1-11, September.
    • Handle: RePEc:gam:jjrfmx:v:16:y:2023:i:9:p:410-:d:1239742
    as

    Download full text from publisher

    File URL: https://www.mdpi.com/1911-8074/16/9/410/pdf
    Download Restriction: no
    File URL: https://www.mdpi.com/1911-8074/16/9/410/
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Terrance Odean, 1999. "Do Investors Trade Too Much?," American Economic Review, American Economic Association, vol. 89(5), pages 1279-1298, December.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Turan G. Bali & Robert F. Engle & Yi Tang, 2017. "Dynamic Conditional Beta Is Alive and Well in the Cross Section of Daily Stock Returns," Management Science, INFORMS, vol. 63(11), pages 3760-3779, November.
    2. Muchnik, Lev & Bunde, Armin & Havlin, Shlomo, 2009. "Long term memory in extreme returns of financial time series," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 388(19), pages 4145-4150.
    3. Youki Kohsaka & Grzegorz Mardyla & Shinji Takenaka & Yoshiro Tsutsui, 2017. "Disposition Effect and Diminishing Sensitivity: An Analysis Based on a Simulated Experimental Stock Market," Journal of Behavioral Finance, Taylor & Francis Journals, vol. 18(2), pages 189-201, April.
    4. Jacobs, Heiko & Müller, Sebastian & Weber, Martin, 2014. "How should individual investors diversify? An empirical evaluation of alternative asset allocation policies," Journal of Financial Markets, Elsevier, vol. 19(C), pages 62-85.
    5. Kenneth Yung & Yen-Chih Liu, 2009. "Implications of futures trading volume: Hedgers versus speculators," Journal of Asset Management, Palgrave Macmillan, vol. 10(5), pages 318-337, December.
    6. Stefano DellaVigna, 2009. "Psychology and Economics: Evidence from the Field," Journal of Economic Literature, American Economic Association, vol. 47(2), pages 315-372, June.
    7. Moeeni , Shahram & Tayebi , Komeil, 2018. "Is It Necessary to Restrict Forex Financial Trading? A Modified Model," Journal of Money and Economy, Monetary and Banking Research Institute, Central Bank of the Islamic Republic of Iran, vol. 13(1), pages 63-80, January.
    8. Camille Magron & Maxime Merli, 2012. "Stocks repurchase and sophistication of individual investors," Working Papers of LaRGE Research Center 2012-02, Laboratoire de Recherche en Gestion et Economie (LaRGE), Université de Strasbourg.
    9. Gaël Giraud & Céline Rochon, 2010. "Transition to Equilibrium in International Trades," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00657038, HAL.
    10. Ricardo Crisóstomo, 2021. "Estimating real‐world probabilities: A forward‐looking behavioral framework," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 41(11), pages 1797-1823, November.
    11. Choi, James J. & Laibson, David & Metrick, Andrew, 2002. "How does the Internet affect trading? Evidence from investor behavior in 401(k) plans," Journal of Financial Economics, Elsevier, vol. 64(3), pages 397-421, June.
    12. Laurent E. Calvet & John Y. Campbell & Paolo Sodini, 2007. "Down or Out: Assessing the Welfare Costs of Household Investment Mistakes," Journal of Political Economy, University of Chicago Press, vol. 115(5), pages 707-747, October.
    13. An, Li & Lou, Dong & Shi, Donghui, 2022. "Wealth redistribution in bubbles and crashes," Journal of Monetary Economics, Elsevier, vol. 126(C), pages 134-153.
    14. Raj Chetty & László Sándor & Adam Szeidl, 2017. "The Effect of Housing on Portfolio Choice," Journal of Finance, American Finance Association, vol. 72(3), pages 1171-1212, June.
    15. Wang, Albert Y. & Young, Michael, 2023. "Mood, attention, and household trading: Evidence from terrorist attacks," Journal of Financial Markets, Elsevier, vol. 66(C).
    16. Garvey, Ryan & Huang, Tao & Wu, Fei, 2016. "Why do traders choose dark markets?," Journal of Banking & Finance, Elsevier, vol. 68(C), pages 12-28.
    17. Muñoz, Francisco, 2013. "Liquidity and firm investment: Evidence for Latin America," Journal of Empirical Finance, Elsevier, vol. 20(C), pages 18-29.
    18. Harbir Lamba, 2010. "How sensitive are equilibrium pricing models to real-world distortions?," Papers 1010.0027, arXiv.org.
    19. Drobetz, Wolfgang & Kugler, Peter & Wanzenried, Gabrielle & Zimmermann, Heinz, 2009. "Heterogeneity in asset allocation decisions: Empirical evidence from Switzerland," International Review of Financial Analysis, Elsevier, vol. 18(1-2), pages 84-93, March.
    20. Natasha Sarin & Lawrence Summers & Owen Zidar & Eric Zwick, 2022. "Rethinking How We Score Capital Gains Tax Reform," Tax Policy and the Economy, University of Chicago Press, vol. 36(1), pages 1-33.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:gam:jjrfmx:v:16:y:2023:i:9:p:410-:d:1239742. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: MDPI Indexing Manager (email available below). General contact details of provider: https://www.mdpi.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.