Fundamental Extrapolation and Stock Returns
European Finance Association 2020 Annual Meeting; American Finance Association 2022 Annual Meeting
74 Pages Posted: 16 Oct 2020 Last revised: 18 Jan 2022
Date Written: August 21, 2020
We propose an economic objective-driven pooling strategy to extrapolate multiple fundamentals simultaneously. This strategy outperforms naive extrapolation strategies that use a single fundamental variable and strategies that use past prices or analyst forecasts, and performs similarly as a machine learning-based pooling strategy. We propose a model to show that fundamental extrapolation has dual price effects: a cash flow effect that pushes stock price up relative to its fundamental value and a discount rate effect that depresses stock price via increasing the expected volatility. Our empirical results suggest that the discount rate effect dominates the cash flow effect.
Keywords: Fundamental Extrapolation; Return Extrapolation; Volatility; Expectation
JEL Classification: G41, G14
Suggested Citation: Suggested Citation