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Another Look to the Price-Dividend Ratio: A Markov-Switching Approach

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Author Info
Juan M. Londoño () (The University of the Basque Country)
Marta Regulez () (The University of the Basque Country)
Jesús Vázquez () (The University of the Basque Country)

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Abstract

A necessary condition for the validity of the present value model is that the price-dividend ratio must be stationary. However, significant market episodes in the late 20th century seem to provide evidence of nonstationarity. This paper analyzes the stationarity of this ratio in the context of a Markov-switching model à la Hamilton (1989) where an asymmetric speed of adjustment is introduced. This particular specification robustly supports a nonlinear reversion process and identifies two relevant episodes: the post-war period from the mid-50’s to the mid-70’s and the so called “90’s boom” period. A three-regime Markov-switching model displays the best regime identification and reveals that only the first part of the 90’s boom (1985-1995) and the post-war period are near-nonstationary states. Interestingly, the last part of the 90’s boom (1996-2000), characterized by a growing price-dividend ratio, is entirely attributed to a regime featuring a highly reverting process.

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Paper provided by University of the Basque Country - Department of Foundations of Economic Analysis II in its series DFAEII Working Papers with number 200809.

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Date of creation: 22 Sep 2008
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Handle: RePEc:ehu:dfaeii:200809

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Postal: Dpto. de Fundamentos del Análisis Económico II, Facultad de CC. Económicas y Empresariales, Universidad del País Vasco, Avda. Lehendakari Aguirre 83, 48015 Bilbao, Spain
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Related research
Keywords: Markov regime-switching; price-dividend ratio stationarity;

Find related papers by JEL classification:
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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