|Stock Market Experiments|
Read first the section "Stock Market Valuation
and the Share of Profits in GDP" in the paper
Fed Policy and the Effects of a Stock
Market Crash on the Economy.
The following experiments rely on this section. It
uses a standard stock-price formula to point out that the
high level of stock prices that existed on June 30, 1999, implied a
high future growth rate of earnings.
The growth rate of earnings was so high as to imply an unrealistically
large ratio of profits to GDP in the future.
The results in the paper are based on a particular set of assumptions
about 1) the length of the horizon, 2) the discount rate, 3) the growth
rate of dividends, and 4) the PE ratio at the end of the horizon. It
is easy to modify the assumptions in the paper and compute alternative
earnings growth rates. This can be done for any time period. The paper
used data as of June 30, 1999, but more recent data can be used.
The following link allows you to use your
own assumptions and see what they imply.
The default values that are used for these computations are based on
data as of December 31, 2017, but you can change these values.
The goal is to find a set of
assumptions that seems sensible and that does not imply an
unrealistically high ratio of profits to GDP in the future.
Can you find such a set? The paper essentially argued that
such a set did not exist for the June 30, 1999, data.
It is also possible to use the stock-price formula to compute what the
S&P stock price should currently be for alternative assumptions about
the future growth rate of earnings. The following link allows you to
Again, the default values are based on data as of December 31, 2017,
but you can change these. You should compare
your computed stock price with the current S&P stock price in
deciding whether the current S&P stock price is too high or too low.
Again, can you find a sensible set of assumptions that justifies the current
S&P stock price and that does not imply an unrealistically high ratio of
profits to GDP in the future?
Testing for a New Economy in the 1990s, Business Economics, January 2004, 43-53.
Risk Aversion and Stock Prices, February 2003.
Shock Effects on Stocks, Bonds, and Exchange Rates, Journal of International Money and Finance, 2003, 307-341.
Events that Shook the Market, Journal of Business, October 2002, 713-732.