Hostname: page-component-586b7cd67f-t7fkt Total loading time: 0 Render date: 2024-11-30T18:53:48.697Z Has data issue: false hasContentIssue false
  • English
  • Français

Temporary Components of Stock Prices: New Univariate Results

Published online by Cambridge University Press:  06 April 2009

B. Espen Eckbo  and
Jian Liu
Get access Rights & Permissions [Opens in a new window]

Abstract

While there is growing evidence that stock prices do not follow pure random walks, the degree of existence of temporary components in stock prices is not well known. Modeling stock prices as the sum of a random walk and a general stationary (predictable) component, the paper proposes an estimable lower bound on the proportion of total stock return variance caused by the predictable component. Contrary to the absolute value of the first-order auto-correlation coefficient estimates of Fama and French (1988a), this lower bound reasonably estimates the true variance proportion in finite samples also when the temporary component does not follow a first-order autoregressive process. The estimated mean values of the lower bound reach a maximum of 10 percent for the equal-weighted market portfolio of NYSE stocks over the post-war period 1947–1986, while the maximum is 25 percent for the pre-war period 1926–1946. The value-weighted market portfolio exhibits generally smaller variance proportion estimates. The pure random walk hypothesis is also reexamined using a standard variance ratio statistic extended to multiple return horizons.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 28 , Issue 2 , June 1993 , pp. 161 - 176
Copyright
Copyright © School of Business Administration, University of Washington 1993

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Bartlett, M. S. “On the Theoretical Specification of Sampling Properties of Auto-Correlated Time-Series.” Journal of Royal Statistical Society, B8 (Spring 1946), 27–42.Google Scholar
Brockwell, P. J., and Davis, R.. Time Series: Theory and Methods. New York, NY: Springer (1987).CrossRefGoogle Scholar
Daniel, K., and Torous, W.. “Common Stock Returns and the Business Cycle.” Working Paper, Univ. of British Columbia (1991).Google Scholar
Fama, E. F. “Efficient Capital Markets: A Review of Theory and Empirical Work.” Journal of Finance, 25 (05 1970), 383–417.CrossRefGoogle Scholar
Fama, E. F., and French, K.. “Permanent and Temporary Components of Stock Prices.” Journal of Political Economy, 96 (04 1988a), 246–273.CrossRefGoogle Scholar
Fama, E. F., and French, K.. “Dividend Yields and Expected Stock Returns.” Journal of Financial Economics, 22 (10 1988b), 3–25.CrossRefGoogle Scholar
Fama, E. F., and French, K.. “Business Conditions and Expected Returns on Stocks and Bonds.” Journal of Financial Economics, 25 (11 1989), 23–49.CrossRefGoogle Scholar
Hansen, L. P., and Hodrick, R. J.. “Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis.” Journal of Political Economy, 88 (10 1980), 829–853.CrossRefGoogle Scholar
Jegadeesh, N. “Seasonality in Stock Price Mean Reversion: Evidence from the U.S. and the U.K. Journal of Finance, 46 (09 1991), 1427–1444.CrossRefGoogle Scholar
Keim, D. B., and Stambaugh, R. F.. “Predicting Returns in the Stock and Bond Markets.” Journal of Financial Economics, 17 (12 1986), 357–390.CrossRefGoogle Scholar
Kim, M. J.; Nelson, C. R.; and Startz, R.. “Mean Reversion in Stock Prices? A Reappraisal of the Empirical Evidence.” Review of Economic Studies, 58 (05 1988), 515–528.CrossRefGoogle Scholar
Lo, A. W., and MacKinlay, A. C.. “Stock Prices Do Not Follow Random Walks: Evidence from a Simple Specification Test.” Review of Financial Studies, 1 (Spring 1988), 41–66.CrossRefGoogle Scholar
Lo, A. W., and MacKinlay, A. C.. “When are Contrarian Profits due to Stock Market Overreaction?” Review of Financial Studies, 3 (Summer 1990), 175–205.CrossRefGoogle Scholar
Poterba, J., and Summers, L.. “Mean Reversion in Stock Prices: Evidence and Implications.” Journal of Financial Economics, 22 (10 1988), 27–59.CrossRefGoogle Scholar
Richardson, M. “Temporary Components of Stock Prices: A Skeptic's View.” Working Paper, Univ. of Pennsylvania (1990).Google Scholar
Summers, L. “Does the Stock Market Rationally Reflect Fundamental Values?” Journal of Finance, 41 (07 1986), 591–601.CrossRefGoogle Scholar