Stock Price Booms and Expected Capital Gains
AbstractThe booms and busts in U.S. stock prices over the post-war period can to a large extent be explained by fluctuations in investors’subjective capital gains expectations. Survey measures of these expectations display excessive optimism at market peaks and excessive pessimism at market throughs. Formally incorporating subjective price beliefs into an otherwise standard asset pricing model with utility maximizing investors, we show how subjective be- lief dynamics can temporarily de-link stock prices from their fundamental value and give rise to asset price booms that ultimately result in a price bust. The model successfully replicates (1) the volatility of stock prices and (2) the positive correlation between the price dividend ratio and expected returns observed in survey data. We show that models imposing objective or ‘rational’price expectations cannot simultaneously account for both facts. Our …findings imply that large part of U.S. stock price fluctuations are not due to standard fundamental forces, instead result from self-reinforcing belief dynamics triggered by these fundamentals.
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Bibliographic InfoPaper provided by Barcelona Graduate School of Economics in its series Working Papers with number 757.
Date of creation: Jan 2014
Date of revision:
Stock Price Volatility; learning; survey expectations; internal rationality;
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
This paper has been announced in the following NEP Reports:
- NEP-ALL-2014-04-11 (All new papers)
- NEP-CFN-2014-04-11 (Corporate Finance)
- NEP-FMK-2014-04-11 (Financial Markets)
- NEP-GER-2014-04-11 (German Papers)
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