Working Paper: CEPR ID: DP4485
Authors: Lubos Pstor; Pietro Veronesi
Abstract: Not necessarily. The fundamental value of a firm increases with uncertainty about average future profitability, and this uncertainty was unusually high in the late 1990s. We calibrate a stock valuation model that includes this uncertainty, and show that the uncertainty needed to match the observed Nasdaq valuations at their peak is high but plausible. The high uncertainty might also explain the unusually high return volatility of Nasdaq stocks in the late 1990s. Uncertainty has the biggest effect on stock prices when the equity premium is low.
Keywords: bubble; uncertainty; valuation
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| uncertainty (D89) | stock prices (G12) |
| uncertainty (D89) | fundamental value of firms (G32) |
| high uncertainty about average future profitability (D89) | high stock prices (G19) |
| uncertainty about growth rates (D89) | higher expected valuations (G19) |
| uncertainty (D89) | return volatility of Nasdaq stocks (C58) |
| low equity premium (G19) | amplified effect of uncertainty on stock prices (D89) |
| low discount rates (E43) | larger impacts from uncertainty on long-term valuations (D81) |
| temporal variation of implied uncertainty (D84) | observed stock price behaviors (G41) |