On the Cointegrating Relationship between Stock Prices and Earnings

The purpose of this study is to investigate a simple present value model Involving earnings (i.e., the earnings discount model) that presumes a relationship between stock prices and earnings. The model suggests a simple linear equilibrium relationship between stock prices and earnings. The tests for cointegration render strong support for the cointegration hypothesis between stock prices (Pt) and earnings (Xt) even at the one-percent significance level. The tests are based on residuals from a cointegrating regression of Pt on Pt+l + Xt. This suggests that there is a stable long-nu equilibrium relationship between stock prices and earnings. The results of the tests lead to the acceptance of the present value model of stock prices involving earnings.