Dynamic Effect of Tobin's Q on Price-to-Earnings Ratio

This study investigates the dynamic effect of the change in aggregate Tobin's q ratio (TBQ) on the percentage change in the S&P 500 price-to-earnings ratio (PE). Based on the analysis of the quarterly market level data from 1951Q4 to 2012Q4, the results show that PE significantly jumps immediately following the shock to TBQ. The results from the Granger-causality tests indicate that TBQ causes PE. There is a reverse causation from PE to TBQ. The variance decomposition results reveal that TBQ forecasts about 10.50% to 17.00% of PE at the two-quarter to eight-quarter horizons