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Long Run and Cyclical Dynamics in the US Stock Market

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Author Info
Guglielmo Maria Caporale ()
Luis A. Gil-Alana ()
Abstract

This paper examines the long-run dynamics and the cyclical structure of various series related to the US stock market using fractional integration. We implement a procedure which enables one to consider unit roots with possibly fractional orders of integration both at the zero (long-run) and the cyclical frequencies. We examine the following series: inflation, real risk-free rate, real stock returns, equity premium and price/dividend ratio, annually from 1871 to 1993. When focusing exclusively on the long-run or zero frequency, the estimated order of integration varies considerably, but nonstationarity is found only for the price/dividend ratio. When the cyclical component is also taken into account, the series appear to be stationary but to exhibit long memory with respect to both components in almost all cases. The exception is the price/dividend ratio, whose order of integration is higher than 0.5 but smaller than 1 for the long-run frequency, and is between 0 and 0.5 for the cyclical component. Also, mean reversion occurs in all cases. Finally, we use six different criteria to compare the forecasting performance of the fractional (at both zero and cyclical frequencies) models with others based on fractional and integer differentiation only at the zero frequency. The results show that the former outperforms the others in a number of cases.

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Paper provided by CESifo GmbH in its series CESifo Working Paper Series with number CESifo Working Paper No. 2046.

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Date of creation: 2007
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Handle: RePEc:ces:ceswps:_2046

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Related research
Keywords: stock market fractional cycles long memory Gegenbauer processes

Find related papers by JEL classification:
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies

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