Measuring the Fundamental Value of a Stock Index through Dividend Future Prices

This study analyzes the dynamic relationship between stock prices and stock fundamentals. We focus on the Euro Stoxx 50 index, a major eurozone stock index, and its dividend futures. From the observed prices of the dividend futures and Euribor (swap) rates, we calculate the transition of term structures for expected dividend growth rates, market risk premiums, and interest rates. Then, we estimate the fundamental values of the stock index through the expected present value formula. Our empirical analyses show that our fundamentals measure is cointegrated with the index price, and that the index price-fundamentals ratio strongly predicts future index returns. These results suggest that the fundamental value constructed in this study could be used as a reasonable measure that tells us whether the current stock price is over- or undervalued. Furthermore, we show from a variance decomposition analysis that the fluctuations in both expected dividend growth rates and risk premiums explain a considerable part of the index variability, while the contribution of the change in interest rates is negligible