Abstract
This study examines the dynamic responses of stock prices to shocks from fundamentals, measured by earnings and dividends. We decompose annual data of aggregate earnings, dividends, and stock prices into permanent and transitory components by taking account of cointegration between the three data series. While raw earnings and dividends together account for only 5% of the stock return variation, about 95% of the variation in stock returns can be explained by permanent earnings and permanent dividends.
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