Professor Pedro Bordalo will present the paper "Expectations of Fundamentals and Stock Market Puzzles"
We revisit several leading aggregate stock market puzzles by incorporating into a standard dividend discount model survey expectations of earnings of S&P 500 firms. Using survey expectations, while keeping discount rates constant, explains a significant part of “excess” stock price volatility, fluctuations in price earnings and price dividend ratios, and return predictability. Expectations about long term earnings growth emerge as a key driver of these pricing anomalies.
The evidence is consistent with a mechanism in which good news about fundamentals leads to excessively optimistic long term earnings forecasts, inflating stock prices and leading to subsequent low returns. Relaxing rational expectations of fundamentals in a standard asset pricing model, guided by empirical measures of expectations and in line with accumulating evidence on overreaction, yields a parsimonious account of stock market puzzles.