How big is the speculative component in Australian share prices?

Abstract

Using 20 years of Australian quarterly data, this paper decomposes Australian share prices into their fundamental and speculative components. To do this we derive the fundamental share-price–output ratio and, hence, the fundamental share-price from a restricted vector-autoregressive model relating the aggregate real share-price index to real output. Our estimations use different assumptions regarding shareholders’ required real rate of return. Our results imply that a significant speculative component exists in share prices (around 10% in mid-2000) and that share-price over/undervaluation has a life-span of around 4 years.