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Learning, Structural Instability, and Present Value Calculations

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  • Hashem Pesaran
  • Davide Pettenuzzo
  • Allan Timmermann

Abstract

Present value calculations require predictions of cash flows both at near and distant future points in time. Such predictions are generally surrounded by considerable uncertainty and may critically depend on assumptions about parameter values as well as the form and stability of the data generating process underlying the cash flows. This paper presents new theoretical results for the existence of the infinite sum of discounted expected future values under uncertainty about the parameters characterizing the growth rate of the cash flow process. Furthermore, we explore the consequences for present values of relaxing the stability assumption in a way that allows for past and future breaks to the underlying cash flow process. We find that such breaks can lead to considerable changes in present values.

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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal Econometric Reviews.

Volume (Year): 26 (2007)
Issue (Month): 2-4 ()
Pages: 253-288

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Handle: RePEc:taf:emetrv:v:26:y:2007:i:2-4:p:253-288

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Related research

Keywords: Bayesian learning; Present value; Stock prices; Structural breaks;

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References

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  1. M. Hashem Pesaran & Davide Pettenuzzo & Allan Timmermann, 2006. "Forecasting Time Series Subject to Multiple Structural Breaks," Review of Economic Studies, Oxford University Press, vol. 73(4), pages 1057-1084.
  2. David Cass & Menahem E. Yaari, 1965. "Individual Saving, Aggregate Capital Accumulation, and Efficient Growth," Cowles Foundation Discussion Papers 198, Cowles Foundation for Research in Economics, Yale University.
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  15. Gary M. Koop & Simon M. Potter, 2004. "Forecasting and estimating multiple change-point models with an unknown number of change points," Staff Reports 196, Federal Reserve Bank of New York.
  16. Timmermann, Allan G, 1993. "How Learning in Financial Markets Generates Excess Volatility and Predictability in Stock Prices," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 1135-45, November.
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