Stock Price with Consumption CAPM: An International Comparison

Abstract

What is the fundamental value of a stock and do prices deviate from it? This paper answers these questions by using a Consumption-Capital Asset Pricing Model. I first show how to express the fundamental price as a function of expected future dividends and consumption as well as of their future conditional variance and covariance. Secondly, I estimate the fundamental price for the United States, the United Kingdom, Japan and Switzerland from 1965 through to 2006. I focus in particular on the impact of the decreasing inflation observed in this period, through structural changes in dividends and in risk premiums or through money illusion. Thirdly, I show that the gap between the price and its fundamental value decreases after a shock, which suggests a link between them. Finally, I show that forecasts using the fundamental price are more accurate than forecasts based on the observed price only or based on simpler fundamental models.