Why do stock prices deviate from fundamentals?

The aim of this paper is to investigate stock price adjustments toward fundamentals in a nonlinear framework. The nonlinearity is justified by the presence of transaction costs and behavioral heterogeneity. Accordingly, it is shown that an on/off nonlinear adjustment model is appropriate to reproduce the dynamics of stock price deviations from fundamentals in developed and emerging countries during more than four decades and within the recent global financial crisis. Our findings show high significant stock price deviations suggesting the failure of fundamentals to explain stock prices movements. In particular, deviations appear to follow a quasi random walk in the central regime when prices are near fundamentals, while they approach a white noise in the outer regimes. Finally, the investigation of stock price adjustment within the period of the recent financial crisis yields more explanation about stock price evolution according to their fundamentals and enable to develop more optimal investment strategies.