Fundamentals or fiction: What drives equity pricing?

Ranjan D'Mello, Mark Gruskin

Research output: Contribution to journalArticle

1 Scopus citations

Abstract

This study employs accounting statements, a source of information consistently available to the markets, to study the role of firm fundamentals and investor sentiment in formulating equity prices. We document that while investors use economic factors to price assets, its importance varies significantly over time and other non-economic factors also play a role. We find that during the "dot.com" years of the late 1990s, investors were optimistic and relied less on underlying financial information in valuing equity, and this effect was most pronounced for NASDAQ-listed firms. The "correction" that began in March 2000 led to an increase in the use of accounting data in price formulation over the next two years. However, the enactment of SOX in 2002 had a much greater impact of enhancing the relevance of accounting information, thereby achieving the intended goal of increasing investors' reliance of fundamentals in stock valuation. We also observe a fall in the role of accounting statements in equity pricing during the 2007 financial crisis, suggesting that reduction in stock prices largely resulted from a changes in investor sentiment and economic conditions rather than declining firm fundamentals. We also find no evidence that the accounting scandals and frauds occurring between 1998 and 2001 had a measurable impact on accounting relevance, suggesting that market efficiency prevented a contagion impact on other firms. Our results suggest that equity valuation is not driven solely by fundamentals, but also by sentiment and behavioral factors which impact share pricing.

Original languageEnglish (US)
Pages (from-to)1-20
Number of pages20
JournalBanking and Finance Review
Volume5
Issue number1
StatePublished - Dec 24 2013

All Science Journal Classification (ASJC) codes

  • Finance
  • Economics and Econometrics

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