A1533
Title: Arbitrage costs and nonlinear adjustments in individual equity prices: A VSTECM modeling
Authors: Fredj Jawadi - University of Evry (France) [presenting]
Abstract: Arbitrage costs cause nonlinear adjustment between equity prices and fundamentals that can be represented by a two-regime ESTECM (Exponential Smooth Transition Error Correction Model). The fundamental values are those estimated previously for 27 of main firms belonging to the French CAC 40 stock price index. These values couple the Dividend Discount Model with the Arbitrage Pricing Theory, the latter determining the long term risk premia included in the discount rate. Accordingly, because fundamental values of equities depend on common factors, the ESTECMs are estimated using a Vector-ESTECM system compounded of the 27 firms. For any firm, it is shown that deviations follow a quasi-random walk in the central regime where prices are near fundamentals (i.e. the mean reversion mechanism is inert when arbitrage costs are greater than expected receipts), while they approach a white noise in the outer regimes (i.e. the mean reversion becomes active when arbitrage cost are lower than expected receipts). As for analyses based on stock price indices, the convergence speed of prices toward fundamentals appeared to depend on the size of the deviation. However, the magnitudes of under- and overvaluation of equity price and the adjustment speed are found to depend strongly both on the date and the firm, which highlight the fact that adjustments of stock price indices hide important disparities between firms.
