Stock Market Performance: Variance Decomposition of Price-Earnings Ratio, Dividend Yield and Tobin's Q
Journal of Financial Transformation, 39, 63-67. April, 2014
14 Pages Posted: 15 Jul 2013 Last revised: 17 Apr 2014
Date Written: July 14, 2013
Abstract
This study examines the relative importance of percentage change in price-to-earnings ratio (PE), percentage change in dividend yield (DY) and change in aggregate Tobin’s q ratio (∆TBQ) in forecasting returns on the S&P 500 (SP). The results from the variance decomposition analysis of quarterly data from 1951Q4 to 2012Q4 show that ∆TBQ beats out PE and DY in forecasting SP. While PE and DY together only forecast about 3.2% of SP at the two-quarter to eight-quarter horizons, ∆TBQ does so at about 66%. The Granger-causality test results reveal that ∆TBQ Granger-causes PE and DY. The generalized impulse response functions of the three variables are also estimated.
Keywords: Tobin’s q ratio, price-earnings ratio, dividend yield, stock market performance
JEL Classification: G12, G14, G17
Suggested Citation: Suggested Citation