International Journal of Business and Economics Volume 6, No. 1 April​, 2007

Expected P/E, Residual P/E, and Stock Return Reversal: Time-Varying Fundamentals or Investor Overreaction?

Ying Huang

School of Business, Manhattan College, U.S.A.

Chia-Hui Tsai

First Taisec Capital Management, Taiwan

Carl R. Chen

Department of Economics and Finance, University of Dayton, U.S.A.

Abstract

We decompose P/E ratios into a fundamental component and a residual component that cannot be explained by the firm or economic fundamentals. Purging the fundamental component from observed P/E ratios, we find that portfolios based on residual P/E ratios exhibit performance reversal only in overbid glamour stocks; hence over-optimism is more prevalent than over-pessimism.

Keywords：P/E ratios, overreaction, market efficiency.

JEL Classifications：G30.

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