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Will the valuation ratios revert to their historical means? Some evidence from breakpoint tests

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  • John B. Carlson
  • Eduard A. Pelz
  • Mark E. Wohar

Abstract

If valuation ratios return to their historical means any time soon, then equity prices must fall substantially, or earnings and dividends must accelerate sharply, or some combination of these events must occur. Historical patterns over the past century suggest that stock prices will fall to align valuation ratios with their means. Of course, the means of the valuation ratios could have changed. To assess the likelihood of such changes, the authors employ breakpoint tests, which allow for multiple breakpoints at unknown break dates. The authors also review alternative explanations for changes in the ratios. They conclude that although no single explanation may be convincing by itself, taken in toto with empirical evidence of structural change, the preponderance of evidence suggests that the mean of the dividend-price ratio is now somewhere between 1% and 2%, probably nearer to 1%. They also conclude that the mean price-to-earnings ratio is now somewhere between 20 and 25, perhaps even higher.

Suggested Citation

  • John B. Carlson & Eduard A. Pelz & Mark E. Wohar, 2001. "Will the valuation ratios revert to their historical means? Some evidence from breakpoint tests," Working Papers (Old Series) 0113, Federal Reserve Bank of Cleveland.
    • Handle: RePEc:fip:fedcwp:0113
    DOI: 10.26509/frbc-wp-200113
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    References listed on IDEAS

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    Cited by:

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    2. Andrew Vivian, 2005. "The Equity Premium: 101 years of Empirical Evidence from the UK," Money Macro and Finance (MMF) Research Group Conference 2005 92, Money Macro and Finance Research Group.
    3. Giot, Pierre & Petitjean, Mikael, 2007. "The information content of the Bond-Equity Yield Ratio: Better than a random walk?," International Journal of Forecasting, Elsevier, vol. 23(2), pages 289-305.
    4. Coakley, Jerry & Fuertes, Ana-Maria, 2006. "Valuation ratios and price deviations from fundamentals," Journal of Banking & Finance, Elsevier, vol. 30(8), pages 2325-2346, August.
    5. McMillan, David G., 2013. "Consumption and stock prices: Evidence from a small international panel," Journal of Macroeconomics, Elsevier, vol. 36(C), pages 76-88.
    6. Boucher, Christophe, 2006. "Stock prices-inflation puzzle and the predictability of stock market returns," Economics Letters, Elsevier, vol. 90(2), pages 205-212, February.
    7. Anne Vila Wetherilt & Simon Wells, 2004. "Long-horizon equity return predictability: some new evidence for the United Kingdom," Bank of England working papers 244, Bank of England.

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    Stock - Prices;

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