Stock prices : fundamentals, bubbles and investor behaviour

This thesis investigates ten markets: U.S., U.K., Hong Kong, Japan Singapore, Malaysia, South Korea, Thailand, Taiwan, and Indonesia over a sample period covering roughly from the 1970s to 2006, in order to investigate whether bubble behaviour is a major source of financial instability. Price movements have fundamental components and bubble components. An attempt to explain price behaviour therefore prompts two major questions: What are the fundamental drivers of stocks? What behaviour causes actual prices to deviate from their fundamental values? This thesis constructs fundamental movements in stock prices by utilising the present value model, which, in turn, involves two further issues. First, do investors expect the required rate of return to be time-varying? Second, which fundamental driver, dividends or earnings, is more efficient in tracing investor perceptions of expected cash flows? I address the former issue by building and testing two models which assume constant discount rate and time-varying discount rate respectively. The second issue we address by using dividends and earnings data as the fundamental factor. Revealed deviations from fundamental value are investigated by considering three types of bubble behaviour discussed in the extant literature: rational explosive bubbles; rational intrinsic bubbles; and irrational price dynamics. Such bubble processes are then compared with actual price movements to gauge which type of behaviour is more likely to track actual prices in the sample markets. With respect to whether the required rate of return is time-varying, two variants of the present value model are used to construct the fundamental values of the relevant market indices. Results demonstrate that the dynamic version of the present value model has superiority in tracking actual price movements when compared to a static version of the present value model. With regard to which series is more effective in tracing investor expected cash flows, the more broadly defined expected earnings, rather than cash dividends, drive stock prices in the developed markets of the U.S., U.K. and Japan, as well as the developing markets of Korea and Malaysia. Dividends have relatively more influence on the markets of Thailand, Taiwan and Indonesia, but neither the dividend discount nor earnings discount model can explain the time path of stock prices in Hong Kong and Singapore. In terms of the drivers of bubble phenomena, results suggest no rational explosive bubble exists in any of the markets in the sample.EThOS - Electronic Theses Online ServiceGBUnited Kingdo