Working Paper: CEPR ID: DP10351
Authors: Rui Albuquerque; Martin Eichenbaum; Dimitris Papanikolaou; Sergio Rebelo
Abstract: A central challenge in asset pricing is the weak connection between stock returns and observable economic fundamentals. We provide evidence that this connection is stronger than previously thought. We use a modified version of the Bry-Boschan algorithm to identify long-run swings in the stock market. We call these swings long-run bull and bear episodes. We find that there is a high correlation between stock returns and fundamentals across bull and bear episodes. This correlation is much higher than the analogous time-series correlations. We show that several asset pricing models cannot simultaneously account for the low time-series and high episode correlations.
Keywords: Stock Market; Returns
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| stock returns (G12) | fundamentals (Y20) |
| fundamentals (Y20) | stock returns (G12) |
| identified bull and bear episodes (E32) | correlation between stock returns and fundamentals (G17) |
| existing asset pricing models (G19) | discrepancies in predictive capabilities (C52) |