Are stock prices driven by expected growth rather than discount rates? Evidence based on the Covid-19 crisis

Pascal Böni, Heinz Zimmermann

Research output: Contribution to journalArticleScientificpeer-review

Abstract

We use the Gordon (1959) constant growth model to gauge the effects from
innovations in implied growth versus discount rates. During the COVID-19 downturn and the Global Financial Crisis (GFC), stock returns were largely affected by a change in the long-run implied growth rate and only to a lesser extent by a change in discount rate, the latter typically used to explain stock returns in the classical asset pricing literature. We reach this conclusion by using ordinary least squares (OLS) regressions of stock returns on the unobservable Gordon factors, which we estimate from firm level valuation ratios D/P, P/E and P/B. The effects from a decrease in implied growth outweigh those from an increase in discount rate by a factor of approximately 1.6 to 1.7. Also, firms with a decrease in implied growth show a stock return that is approximately 6.6% more negative than that of firms with no decrease in implied growth. Investors can infer valuable information from the joint interpretation of underlying market fundamentals as derived from the Gordon model.
Original languageEnglish
JournalRisk Management
DOIs
Publication statusE-pub ahead of print - 12 Mar 2021

Keywords

  • Stock market valuation
  • COVID-19 stock market downturn
  • Gordon model
  • valuation multiples

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