Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/197844 
Authors: 
Year of Publication: 
2017
Series/Report no.: 
Bank of Canada Staff Working Paper No. 2017-38
Publisher: 
Bank of Canada, Ottawa
Abstract: 
Stock market fundamentals would not seem to meaningfully predict returns over a shorter-term horizon - instead, I shift focus to severe downside risk (i.e., crashes). I use the cointegrating relationship between the log S&P Composite Index and log earnings over 1871 to 2015, combined with smoothed earnings, to first construct a counterfactual valuation benchmark. The price-versus-benchmark residual shows an improved, and economically meaningful, logit estimation of the likelihood of a crash over alternatives such as the dividend yield and price momentum. Rolling out-of-sample estimates highlight the challenges in this task. Nevertheless, the overall results support the common popular belief that a higher stock market valuation in relation to fundamentals entails a higher risk of a crash.
Subjects: 
Asset pricing
Financial stability
JEL: 
G0
G01
G12
G17
G19
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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