A
Generalized Earnings-Based Stock Valuation Model
This paper provides a model for valuing stocks that takes into account
the stochastic processes for earnings and interest rates. Our analysis
differs from past research of this type in being applicable to stocks that
have a positive probability of zero or negative earnings. By avoiding the
singularity at the zero point, our earnings-based pricing model achieves
improved pricing performance. The out-of-sample pricing performance of
Generalized Earnings Valuation Model (GEVM) and the Bakshi and Chen (2001)
pricing model are compared on four stocks and two indices. The generalized
model has smaller pricing errors, and greater parameter stability. Furthermore,
deviations between market and model prices tend to be mean-reverting using
the GEVM model, suggesting that the model may be able to identify stock
market misvaluation.
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