Why the High Values for the CAPE Ratio in Recent Years Might Be Justified
Round 1
Reviewer 1 Report
In the presented paper, the author delves into a comprehensive exploration of the CAPE ratio and its relevance in the contemporary financial realm. The work is notable for its innovative approach to tracking errors from a fresh perspective. Moreover, the paper's application of the Gordon Growth Model to the P/E Ratio offers valuable insights, effectively linking established financial theory with modern market dynamics. Throughout the analysis, the author rigorously examines the CAPE ratio in the context of the S&P500 Index, providing a valuable lens into the dynamics of a prominent financial market indicator in today's environment.
Flaws and Suggestions for Improvement:
1. The research design of the work requires special attention. Tables, literature citations, and overall formatting need refining to ensure a coherent and professional presentation.
2. The introduction section should delve deeper into contemporary sources. A mere two references post-2018 have been examined, which need to be revised for a topic of this breadth and complexity. Expanding the literature review to incorporate more recent research and perspectives will enhance the paper's relevance and depth.
3. The tables present the analysis results, including regression, as evident in Table 1, but the paper needs a more straightforward presentation of the initial data. Also, the methodology for conducting this analysis must be explicitly detailed. To bolster credibility and clarity, it is essential to detail the data collection process and the specific analytical techniques used.
4. A notable omission in the paper is the need for more graphical data representation. Incorporating diagrams, charts, and other visual tools can significantly aid in understanding and illustrating the CAPE ratio indicators, source data, and model adequacy assessments. Such visual aids can enhance both the comprehensibility and appeal of the work.
5. In the concluding section, it is pivotal for the author to elucidate the scientific novelty of the research, going beyond just the practical results. An explicit statement of what sets this research apart regarding novel approaches or findings will solidify the paper's academic significance. The conclusions sometimes appear generalised and need more specific pointers for investors or market analysts. Additionally, the predictive performance of the CAPE ratio could be emphasised more about the simple P/E ratio. Moreover, outlining the prospects for further development or future avenues of research will provide a trajectory for readers and future researchers in the domain.
In summation, while the paper is undoubtedly a valuable contribution to the discourse on the CAPE ratio and its relevance in modern finance, there are several areas where improvements are necessary. With these enhancements, especially in the research design and a more detailed exposition of methodology and data, the paper has the potential to stand out as a seminal work in its domain.
Author Response
Thank you for the excellent comments and suggestions. I’ve made substantial changes to the paper based on your suggestions. I will briefly respond to your comments and direct you to the correct sections of the revised paper if needed. Since the paper has been revised substantially, I disabled the tracking for changes.
Flaws and Suggestions for Improvement:
- The research design of the work requires special attention. Tables, literature citations, and overall formatting need refining to ensure a coherent and professional presentation.
-Agreed! The paper has been revised substantially. 3 new graphs and 2 new tables were added to make the paper easier to follow.
- The introduction section should delve deeper into contemporary sources. A mere two references post-2018 have been examined, which need to be revised for a topic of this breadth and complexity. Expanding the literature review to incorporate more recent research and perspectives will enhance the paper's relevance and depth.
-There are relatively limited papers focusing on CAPE Ratio. But, during the revision process, I realized that using CAPE Ratio to forecast 10-year excess CAPE yield is essentially the same as forecasting equity risk premium. I added a few papers addressing the issue. It has a vast literature and it would be too ambitious to try to address it along with CAPE Ratio.
- The tables present the analysis results, including regression, as evident in Table 1, but the paper needs a more straightforward presentation of the initial data. Also, the methodology for conducting this analysis must be explicitly detailed. To bolster credibility and clarity, it is essential to detail the data collection process and the specific analytical techniques used.
-Agreed. A table summarizing the data has been added.
- A notable omission in the paper is the need for more graphical data representation. Incorporating diagrams, charts, and other visual tools can significantly aid in understanding and illustrating the CAPE ratio indicators, source data, and model adequacy assessments. Such visual aids can enhance both the comprehensibility and appeal of the work.
-Agreed. Three graphs were added. They were useful for visualizing the structural changes.
- In the concluding section, it is pivotal for the author to elucidate the scientific novelty of the research, going beyond just the practical results. An explicit statement of what sets this research apart regarding novel approaches or findings will solidify the paper's academic significance. The conclusions sometimes appear generalised and need more specific pointers for investors or market analysts. Additionally, the predictive performance of the CAPE ratio could be emphasised more about the simple P/E ratio. Moreover, outlining the prospects for further development or future avenues of research will provide a trajectory for readers and future researchers in the domain.
-Agreed. I added couple of new ideas other researcher can look into. The main purpose of this paper is to provide a caution against market-timing, a counter point to the theme of the special issue.
Reviewer 2 Report
The paper titled "Is the CAPE Ratio Too High or the Risk-Free Rate Too Low: 2 Comparing the Predictive Performances of the CAPE Ratio and 3 Simple P/E Ratio" provides new insights into market timing using valuation ratios such as CAPE. While my overall evaluation is positive, I suggest some minor improvements.
1. The title could be shortened.
2. I find using Wikipedia links rather bizarre, especially in the abstract. I rather recommend removing them.
3. The abstract should be sharpened and shortened a bit.
4. The introduction should be substantially rewritten and restructured. Ideally, the authors should start explaining what they are doing in the 2nd paragraph and start summarizing the findings by the third. Literature contributions should follow this. I recommend the authors look at John Cochrane's guidelines on article writing, which I myself found quite useful (https://www.fma.org/assets/docs/membercontent/writing_cochrane.pdf).
4. Please ensure all tables are self-contained; add the necessary notes.
5. The literature review is very selective and misses important contributions. I recommend that the authors cite the seminal papers on market risk premium predictability, such as:
- Welch, I., & Goyal, A. (2008). A comprehensive look at the empirical performance of equity premium prediction. The Review of Financial Studies, 21(4), 1455-1508.
as well as some newer studies aggregating numerous predictors, e.g.,
- Hollstein, F., Prokopczuk, M., Tharann, B., & Wese Simen, C. (2020). Predicting the equity premium around the globe: Comprehensive evidence from a large sample. Available at SSRN 3567622.
- Zhou, X., Zhou, H., & Long, H. (2023). Forecasting the equity premium: Do deep neural network models work? Modern Finance, 1(1), 1–11.
- Goyal, A., Welch, I., Zafirov, A. (2021) A Comprehensive Look at the Empirical Performance of Equity Premium Prediction II. Swiss Finance Institute Research Paper Series 21-85, Swiss Finance Institute.
6. All abbreviations and terms should be explained appropriately before they are used for the first time. For example, what is the Excess CAPE Yield (ECY)?
Author Response
Thank you for the excellent comments and suggestions. I’ve made substantial changes to the paper based on your suggestions. I will briefly respond to your comments and direct you to the correct sections of the revised paper if needed. Since the paper has been revised substantially, I disabled the tracking for changes.
- The title could be shortened.
-Agreed. It was a hard choice for me when I picked the previous title as I want to convey the central idea of the paper. I’ve shortened it.
- I find using Wikipedia links rather bizarre, especially in the abstract. I rather recommend removing them.
-I did not see the links referenced. Might be an issue when I reformatted the paper for the style for the journal. I’ve revised the abstract.
- The abstract should be sharpened and shortened a bit.
-Agreed. It has been completely rewritten.
- The introduction should be substantially rewritten and restructured. Ideally, the authors should start explaining what they are doing in the 2nd paragraph and start summarizing the findings by the third. Literature contributions should follow this. I recommend the authors look at John Cochrane's guidelines on article writing, which I myself found quite useful (https://www.fma.org/assets/docs/membercontent/writing_cochrane.pdf).
-Thank you for the excellent suggestion. I did not know about the paper by Professor Cochrane. I will follow it in my future research writings as well.
- Please ensure all tables are self-contained; add the necessary notes.
-Agreed. I make sure the necessary notes are added.
- The literature review is very selective and misses important contributions. I recommend that the authors cite the seminal papers on market risk premium predictability, such as. . .
-Thank you for the suggestion to look into the equity risk premium topic. I realized that predicting CAPE excess yield is essentially trying to forecast future equity risk premium! In fact, I believe Campbell and Shiller wrote the original CAPE Ratio paper based on their works on equity risk premium. It is too vast of an topic for this paper to have a full discussion of the connections between the two. I added the referenced papers suggested.
Round 2
Reviewer 1 Report
Thank you to the authors for the major revision. The paper is almost ready for publication. Please pay attention to the following typos:
1. In Table 2, in the "Intercept" column, the figures 0.083 and 0.42 are indicated. However, in the text (lines 210-212), it is mentioned that these are slopes, but the slopes are 11.43 and 14.73 in Table 2. Which is correct?
2. Table 2 presents the absolute value of the t-statistic; however, it should provide a comparable p-value or a similar probabilistic estimate.
The paper can be recommended for printing after minor revision.
Author Response
I thank the referee for carefully reviewing the revised draft and pointing out the errors in Table 2.
1. In Table 2, in the "Intercept" column, the figures 0.083 and 0.42 are indicated. However, in the text (lines 210-212), it is mentioned that these are slopes, but the slopes are 11.43 and 14.73 in Table 2. Which is correct?
-I had the Intercept and Slope columns mixed up! It had been corrected.
2. Table 2 presents the absolute value of the t-statistic; however, it should provide a comparable p-value or a similar probabilistic estimate.
-I followed the suggestion and reported the t-statistics under the estimates and added p-values for the estimates, as well as the adjusted-R2.
