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Valuation bias in the stock market

Jarkasy, Samer (2005). Valuation bias in the stock market. (Unpublished Doctoral thesis, City University, London)


In our first study (Chapter 3) we investigate valuation bias in the UK stock market by examining the valuation of new stocks relative to survivor stocks as new stocks have relatively higher valuations with the valuation gap increases in bullish markets and vice versa. The value explanatory model and individual fundamental factor tests developed provide evidence of a negative significant relation between age and value. This does not seem to be backed by any known economic rationale given that new stocks showed lower profitability levels, no concrete evidence of materialised higher growth or lower risk which is inconsistent with their relatively higher valuations indicating that valuation bias could well be present.

The evidence in the first study does not imply that valuation of survivor stocks is rational or otherwise. Hence, in our second study (Chapter 4), we seek evidence on valuation bias at the stock market aggregate level where the occurrence of major divergences between stock prices on one side and economic growth and equity invested capital on the other, followed by subsequent price falls (corrections) is evident. The evidence obtained shows: (a) low earnings yields using theoretical and empirical models under plausible scenarios, (b) no changes in corporate profitability pattern that could explain stock price levels, (c) a cyclical gap between implied growth and economic growth, (d) that implied growth was almost always higher than both economic and earnings realised growth, and finally (e) the implied average equity risk premium compared with the evidence in the literature and the market unbiased expected return appears to underestimate risk revealing a paradox of high return expectations driving prices up implying lower equity risk premium. The evidence on balance, suggests that stock price levels in the UK during 1989-2002 cannot be explained by fundamentals and the idea of temporary mispricing is not supported by strong evidence leaving the door open to argue the presence of overvaluation on average during 1989-2002.

One of the implications of valuation bias and stock age is that investors are relatively more limited in exaggerating the potential of survivor stocks because of the better investment knowledge available about them compared to new stocks. Thus, in our third study (Chapter 5), we seek evidence for the role of ‘investment knowledge’ in ‘stock price rationalisation’ from property investment stocks exploiting the special investment characteristics of their underlying assets and operations. We establish the presence of a significant and enduring market discount to the underlying value for property investment stocks. We test the hypothesis that property investment stocks discount is a reflection of investment knowledge-based rationality that limits valuation bias for these stocks. In testing the hypothesis, we establish knowledge-based rational explanations for property stocks market valuation or discount. The evidence from return differential, operating expenses, capital gains risk, leverage risk, and the stability of property stock prices, unlike the overall stocks market, relative to the economy and the underlying value leads towards not rejecting the null hypothesis.

Publication Type: Thesis (Doctoral)
Subjects: H Social Sciences > HG Finance
Departments: Bayes Business School
Bayes Business School > Finance
Doctoral Theses
Bayes Business School > Bayes Business School Doctoral Theses
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