On the predictive power of CAPE or Shiller’s PE ratio: the case of the Greek stock market

Abstract

This paper examines the capability of the Cyclically Adjusted Price to Earnings (CAPE) or Shiller's P/E ratio, along with other relative valuation ratios such as the P/E and the P/BV, to predict future returns of the FTSE/ASE Large Cap Index, starting from the development of the index (1997) to December 2018. We have herein used several regression models in order to examine the relationship between the above ratios and the future returns of 1, 3, 5 and 10 years. We show that, while P/E and P/BV ratios are not correlated to future returns, the CAPE ratio and its variation CAPE 5, which uses real 5 year earnings, are efficient estimators of future returns. Our results imply the informational inefficiency of the Greek Stock Market.

The effect of corruption on the level of real and accrual earnings management in cases of target firms

“…, 2018). The knowledge about the target firm's future performance can be taken into consideration by investors in their attempt to determine the intrinsic value of each security in order to identify investment opportunities (Kenourgios et al. , 2021).…”

“…Past research discussed the effect of earnings management on the future earnings and stock market performance, either using accrual-based methods (Rangan, 1998;Teoh et al, 1998;DuCharme et al, 2004;Lim et al, 2008) or real-activities manipulations (Graham et al, 2005;Cohen et al, 2008;Gunny, 2010;Kothari et al, 2016;Jiang et al, 2018). The knowledge about the target firm's future performance can be taken into consideration by investors in their attempt to determine the intrinsic value of each security in order to identify investment opportunities (Kenourgios et al, 2021). Louis (2004) verified the negative impact of accruals earnings management on the acquirer's underperformance, while Farooqi et al (2017) EMJB 18,4 confirmed that real earnings management reversals are negatively related to acquiring firm's performance.…”

A modified Shiller's cyclically adjusted price-to-earnings (CAPE) ratio for stock market index valuation in a zero-interest rate environment

“…They found that the sales-to-price metric and their composite model improved their prediction of 10-year stock returns in the S&P500 and resulted in a correlation between out-of-sample forecasts and actual returns of 0.87 and significantly reduced the standard deviation of the forecast error. Kenourgios, Papathanasiou, & Bampili (2021) published a study on the predictive ability of the CAPE ratio in the Greek stock market, using both five and ten years of trailing real earnings for the Athens Stock Exchange Large Cap Index. The authors found that the CAPE ratio appeared to be the best predictor of stock market returns only for long-term returns, and its ability to predict returns diminished as the return's horizon shortened.…”

“…This analysis was conducted by establishing the Pearson's coefficient for these variables and the results thereof, tabled for discussion in the form of a heatmap again. Several other authors use correlations to test the relationships between similar variables, including Kenourgios et al (2021), Jivraj & Shiller (2017) and Algaba & Boudt (2017).…”

“…Several studies raise concerns regarding the reliability of long-term predictability regressions of time-series data (Baek & Lee, 2018, p. 119;Kenourgios et al, 2021;Jivraj & Shiller, 2017;Cejnek & Randl, 2020, p. 1240Dimitrov & Jain, 2018, p. 755;Zakamulin, 2017). Of particular concern is heteroskedasticity and autocorrelation (serial correlation) which is prevalent in time-series data and is caused by overlapping data (Philips & Ural, 2016, p. 117).…”