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A counterfactual valuation of the stock index as a predictor of crashes: FB3-5/2017-38E-PDF

“Stock market fundamentals would not seem to meaningfully predict returns over ashorter-term horizon—instead, the author shifts focus to severe downside risk (i.e., crashes). The author uses the cointegrating relationship between the log S&P Composite Index and log earnings over 1871 to 2015, combined with smoothed earnings, to first construct a counterfactual valuation benchmark. The price-versus-benchmark residual shows an improved, and economically meaningful, logit estimation of the likelihood of a crash over alternatives such as the dividend yield and price momentum. Rolling out-of-sample estimates highlight the challenges in this task. Nevertheless, the overall results support the common popular belief that a higher stock market valuation in relation to fundamentals entails a higher risk of a crash"--Abstract, p. ii.

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Department/Agency Bank of Canada.
Title A counterfactual valuation of the stock index as a predictor of crashes
Series Title Bank of Canada staff working paper,
Publication Type Series - View Master Record
Language [English]
Format Electronic
Electronic Document

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Note "September 2017."
Date 2017.
Number of Pages ii, 1, 58 p. :
Catalogue Number
  • FB3-5/2017-38E-PDF
Subject Terms Stock markets, Financial crisis, Forecasting