Stock Market Market Crash of 2008: an empirical study of the deviation of share prices from company fundamentals

TL;DR

This study quantitatively analyzes the deviation of share prices from company fundamentals during the 2008 stock market crash, revealing overvaluation before and undervaluation during the crisis using a panel regression model on a large global dataset.

Contribution

It introduces a panel regression approach with fixed effects to extract unobservable company fundamentals and quantify market deviations during the 2008 crisis.

Findings

Share prices were overvalued before 2008

Share prices were undervalued during 2008

Market fluctuations were excessive around the crisis period

Abstract

The aim of this study is to investigate quantitatively whether share prices deviated from company fundamentals in the stock market crash of 2008. For this purpose, we use a large database containing the balance sheets and share prices of 7,796 worldwide companies for the period 2004 through 2013. We develop a panel regression model using three financial indicators--dividends per share, cash flow per share, and book value per share--as explanatory variables for share price. We then estimate individual company fundamentals for each year by removing the time fixed effects from the two-way fixed effects model, which we identified as the best of the panel regression models. One merit of our model is that we are able to extract unobservable factors of company fundamentals by using the individual fixed effects. Based on these results, we analyze the market anomaly quantitatively using the divergence rate--the rate of the deviation of share price from a company's fundamentals. We find that share prices on average were overvalued in the period from 2005 to 2007, and were undervalued significantly in 2008, when the global financial crisis occurred. Share prices were equivalent to the fundamentals on average in the subsequent period. Our empirical results clearly demonstrate that the worldwide stock market fluctuated excessively in the time period before and just after the global financial crisis of 2008.