2017/10/27 by Robert D. Arnott, Denis B. Chaves, Tzee-man Chow · 15 citations
Business, Management and Accounting · Economics, Econometrics and Finance · #Econometrics #Economics #Financial Markets and Investment Strategies #Financial Reporting and Valuation Research #Financial economics #Housing Market and Economics #Inflation (cosmology) #Interest rate #Mean reversion #Monetary economics #Valuation (finance)
paper · doi:10.3905/jpm.2017.44.1.055
published in The Journal of Portfolio Management 44(1), 55-68 (Euromoney Institutional Investor)
openalex publication_date 2017/10/27 · openalex created_date 2025/10/10 · openalex updated_date 2026/07/30
Because of mean reversion, the Shiller cyclically adjusted price/earnings (P/E) ratio is a powerful predictor of long-horizon capital market returns. Like other valuation metrics, however, it is a poor predictor of short-term returns. The authors find that this is because the “normal” level of the Shiller P/E ratio varies with economic conditions. Other researchers have shown that while periods of moderate real interest rates allow higher market valuations, P/Es tend to fall when real rates are high or low. The present authors show a similar linkage between P/Es and inflation. Moderate, rather than rock-bottom, levels of inflation and real interest rates are associated with the highest valuation multiples, creating a valuation “mountain.” The authors also extend these findings to international developed markets. They further demonstrate that the P/E ratio becomes a statistically significant and economically meaningful predictor of shorter-term returns under the assumption that P/Es mean-revert toward the levels suggested by prevailing macroeconomic conditions rather than toward long-term averages. <b>TOPICS:</b>Accounting and ratio analysis, developed