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A dynamic analysis of stock price ratios

Author

Listed:
  • Antoine Giannetti
  • Ariel Viale

Abstract

Stock price ratios have long been used by finance practitioners as a relative value metric. A popular argument for this widespread use is that stock price ratios tend to revert to their long-run mean so that substantial deviations from historical averages could successfully be arbitraged away. In this work, we lay out the theoretical conditions for the ratio of stock prices to be a stationary process. In particular, we theoretically relate price ratio stationarity to economic mean reversion in profitability (as measured by dividends or earnings price ratios) across securities. We further test our theoretical predictions using a popular example of 'close' stocks.

Suggested Citation

  • Antoine Giannetti & Ariel Viale, 2011. "A dynamic analysis of stock price ratios," Applied Financial Economics, Taylor & Francis Journals, vol. 21(6), pages 353-368.
    • Handle: RePEc:taf:apfiec:v:21:y:2011:i:6:p:353-368
    DOI: 10.1080/09603107.2010.530219
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    References listed on IDEAS

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    1. Robert J. Shiller, 1984. "Stock Prices and Social Dynamics," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 15(2), pages 457-510.
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