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Cointegration Tests of Present Value Models with a Time-Varying Discount Factor

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  • Timmermann, Allan

Abstract

The paper analyses the impact of persistence and volatility in the discount rate in present-value models on conintegration tests in levels and in logarithms. In simulations we find that the probability of not rejecting the null of no cointegration depends on the persistence of the discount rate process and can be very high when the expected returns process is highly persistent. In contrast, the cointegration tests are very robust with respect to the level of volatility in the discount rate. We discuss the relevance of our findings for the U.S. stock market where standard ADF tests do not reject the null of no cointegration between stock prices and dividends. Based on estimates of persistence in four asset pricing models, we find that a model which links expected returns to the dividend yield is sufficiently persistent to explain the failure of rejecting the null that stock prices and dividends are not cointegrated. Copyright 1995 by John Wiley & Sons, Ltd.

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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.

Volume (Year): 10 (1995)
Issue (Month): 1 (Jan.-March)
Pages: 17-31

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Handle: RePEc:jae:japmet:v:10:y:1995:i:1:p:17-31

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Cited by:
  1. Tsangyao Chang & Wen-Chi Liu, 2008. "Rational Bubbles in the Korea Stock Market? Further Evidence based on Nonlinear and Nonparametric Cointegration Tests," Economics Bulletin, AccessEcon, vol. 3(34), pages 1-12.
  2. Edward Bernard Bastiaan de Rivera y Rivera & Diógenes Manoel Leiva Martin & Emerson Fernandes Marçal & Leonardo Fernando Cruz Basso, 2012. "Present value model between prices and dividends with constant and time-varying expected returns: enterprise-level Brazilian stock market evidence from non-stationary panels," Brazilian Business Review, Fucape Business School, vol. 9(4), pages 51-86, October.
  3. Kanas, Angelos, 2005. "Nonlinearity in the stock price-dividend relation," Journal of International Money and Finance, Elsevier, vol. 24(4), pages 583-606, June.
  4. Christophe Boucher, 2003. "Stock Market Valuation : the Role of the Macroeconomic Risk Premium," Finance 0305011, EconWPA.
  5. Cunado, J. & Gil-Alana, L.A. & de Gracia, F. Perez, 2005. "A test for rational bubbles in the NASDAQ stock index: A fractionally integrated approach," Journal of Banking & Finance, Elsevier, vol. 29(10), pages 2633-2654, October.
  6. Gallagher, Liam A & Taylor, Mark P, 2001. "Risky Arbitrage, Limits of Arbitrage, and Nonlinear Adjustment in the Dividend-Price Ratio," Economic Inquiry, Western Economic Association International, vol. 39(4), pages 524-36, October.
  7. Nasseh, Alireza & Strauss, Jack, 2004. "Stock prices and the dividend discount model: did their relation break down in the 1990s?," The Quarterly Review of Economics and Finance, Elsevier, vol. 44(2), pages 191-207, May.
  8. Bohl, Martin T., 2003. "Periodically collapsing bubbles in the US stock market?," International Review of Economics & Finance, Elsevier, vol. 12(3), pages 385-397.
  9. Nasseh, Alireza & Strauss, Jack, 2000. "Stock prices and domestic and international macroeconomic activity: a cointegration approach," The Quarterly Review of Economics and Finance, Elsevier, vol. 40(2), pages 229-245.
  10. Engsted, Tom, 2006. "Explosive bubbles in the cointegrated VAR model," Finance Research Letters, Elsevier, vol. 3(2), pages 154-162, June.
  11. Vyacheslav Mikhed & Petr Zemcik, 2007. "Do House Prices Reflect Fundamentals? Aggregate and Panel Data Evidence," CERGE-EI Working Papers wp337, The Center for Economic Research and Graduate Education - Economic Institute, Prague.
  12. Fanelli, Luca, 2002. "A new approach for estimating and testing the linear quadratic adjustment cost model under rational expectations and I(1) variables," Journal of Economic Dynamics and Control, Elsevier, vol. 26(1), pages 117-139, January.
  13. Ye, Yonggang & Chang, Tsangyao & Hung, Ken & Lu, Yang-Cheng, 2011. "Revisiting rational bubbles in the G-7 stock markets using the Fourier unit root test and the nonparametric rank test for cointegration," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 82(2), pages 346-357.

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