Will the Valuation Ratios Revert to their Historical Means ?Some Evidence from Breakpoint Tests
If valuation ratios return to their historical means any time soon, then either equity prices must fall substantially or earnings and dividends must accelerate sharply, or some combination of these events must happen. Historical patterns over the past century or so suggest that stock prices will fall to align valuation ratios with their means. Of course, the means of the valuation ratios could have changed. To assess the likelihood of such changes, the authors employ breakpoint tests on the means of the valuation ratios. The test procedures employed allow for multiple breakpoints at unknown break dates. The authors also review alternative explanations for changes in the ratios. Although no single explanation may be convincing by itself, taken in toto with empirical evidence of structural change, the authors conclude that the preponderance of evidence suggests that the mean of the dividend-price ratio is now somewhere between 1% and 2%, probably nearer to 1%. They also conclude that the mean price-to-earnings ratio is now somewhere between 20 and 25, perhaps even higher.
JEL Codes: G12
Key Words: price-earnings ratio, dividend price ratio, asset pricing
Suggested citation: Carlson, John B., Eduard A. Pelz and Mark Wohar, 2001. “Will the Valuation Ratios Revert to their Historical Means ?Some Evidence from Breakpoint Tests,” Federal Reserve Bank of Cleveland, Working Paper, no. 01-13.