Expected Growth, Investor Sentiment And Equity Valuation

There have been high valuation ratios in China’s ChiNext market since its inception. There are many discussions around the phenomenon in academic community. Some argue that high valuation ratios originate from explosive behavior like what happened in the late-1990s NASDAQ market, while some others argue that it can be explained by the higher earnings growth expectation. To classify these arguments, a series of econometric financial bubble tests are applied in ChiNext market, which have successfully detected the explosive behavior in NASDAQ. However, the empirical results fail to reject the null hypothesis and can’t justify the existence of asset bubble(s) in ChiNext market. Then, several econometric models are established for further insights about the sources of high valuation ratios in the market. Results from these models show evidence of strong positive correlations between valuation ratios and growth expectations. The relationship is termed as growth premium. High valuation ratios can be partially justified by the growth premium. However, growth premiums fluctuate substantially over time across ChiNext market, Main Board and SME Board. Further investigation shows that positive relationships exist between investor sentiment and growth premiums among the three markets. When investor sentiment is high, the difference of future returns among the three markets are not statistically significant; when investor sentiment is low, future returns of ChiNext outperform those of SME Board, which outperform the Main Board. Further research shows that portfolios with higher growth expectations outperform portfolios with relative low growth expectations in ChiNext market whether investor sentiment is high or not. Finally, we can conclude that higher valuation ratios in ChiNext market are driven by higher growth premium in the market than in Main Board and in SME Board.