The Information Content of Earnings and Prices : A Simultaneous Equations Approach

The price-earnings relation can be characterized as a system of simultaneous equations. Earnings may change for reasons that do not lead to price changes and vice versa. Hence each behaves as if it is quot;measured with errorquot; for purposes of estimating the sensitivity coefficients. Equation-by- equation estimation is deficient because of underidentification and bias. Across a variety of specifications the coefficients increase dramatically in moving from OLS to 3SLS and provide less divergent estimates of the underlying parameters. The study documents that a substantial portion of the bias can be mitigated via joint estimation