I’ve been e-mailing lots of people to let them know about my article reporting on The Silencing of Academic Researcher Wade Pfau by the Buy-and-Hold Mafia.
Yesterday’s blog entry reported on my correspondence with Economics Professor Valeriy Zakamulin. Set forth below is the text of an e-mail sent by Valeriy in response to the e-mail of mine detailed in the earlier blog entry:
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Rob:
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First of all I would like to comment the following:
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What I am telling in this context is that if the PE10 ratio is way too high or way too low, then the precision of your forecast (the range of possible outcomes as measured for example by plus minus one standard deviation) is rather good. If the PE10 ratio is close to its long-run mean, then the range of possible outcomes is too wide to be useful for forecasting.
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My comment on the following: If we tell people how stock investing works, we will never see such extreme P/E10 values again. Once we get the word out, stock prices become self-regulating. If people understand that they MUST change their stock allocations in response to big price swings, each swing upward will bring on sales and those sales will pull prices back to fair-value levels again. There can never be another bull market or another bear market once we permit open discussion of Shiller’s findings.
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First of all, it seems to me that we agree that people are not fully rational. Second, it will not be correct to say that it is rational that the PE10 ratio should always be about 15. In a rational expectation model the value of PE (hence PE10) depends on some, sometimes unobservable, parameters. For example, the investor’s risk aversion, the derivative of which is the market price of risk. Third, I do believe that the Shiller’s work did its job, now many people understand that it is not rational to have a PE10 value of 44. Forth, despite this, even in a rational expectation framework if the bubble occurs, it is rational to participate in it. As an example, image that you are in 1993 and you see a bubble in the stock market, yet the economic outlook is very bright, the investors’ optimism is high, and it looks like the bull market will continue for a long time. Will you get out of the stocks and miss the bull market till 2001? I doubt.
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Valeriy
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