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Intrinsic Bubbles and Fat Tails in Stock Prices

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  • Prasad Bidarkota

    ()
    (Department of Economics, Florida International University)

Abstract

We study the constant discount rate present value model for stock pricing in a stochastic setting where the exogenous dividend stream is modeled as a random walk with innovations drawn from the family of stable distributions. We derive an exact analytical solution for the fundamental stock price. We evaluate the ability of the model fundamentals and the dividends-driven intrinsic bubbles to explain the observed variation in annual US stock prices. We compare results obtained in this setting with those from the traditional model where all stochastic processes are driven by Gaussian shocks.

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File URL: http://casgroup.fiu.edu/pages/docs/2248/1280267797_03-06.pdf
File Function: First version, 2003
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Bibliographic Info

Paper provided by Florida International University, Department of Economics in its series Working Papers with number 0306.

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Length: 36 pages
Date of creation: Sep 2003
Date of revision:
Handle: RePEc:fiu:wpaper:0306

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Postal: Miami, FL 33199
Phone: (305) 348-2316
Fax: (305) 348-1524
Web page: http://casgroup.fiu.edu/Economics/
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Related research

Keywords: Stock prices; present-value model; intrinsic bubbles; fat tails; normal distributions; stable distributions;

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  1. Driffill, John & Sola, Martin, 1998. "Intrinsic bubbles and regime-switching," Journal of Monetary Economics, Elsevier, vol. 42(2), pages 357-373, July.
  2. Lux, Thomas & Sornette, Didier, 2002. "On Rational Bubbles and Fat Tails," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(3), pages 589-610, August.
  3. Robert J. Shiller, 1980. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," NBER Working Papers 0456, National Bureau of Economic Research, Inc.
  4. Benoit Mandelbrot, 1963. "The Variation of Certain Speculative Prices," The Journal of Business, University of Chicago Press, vol. 36, pages 394.
  5. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
  6. Kenneth A. Froot & Maurice Obstfeld, 1992. "Intrinsic Bubbles: The Case of Stock Prices," NBER Working Papers 3091, National Bureau of Economic Research, Inc.
  7. LeRoy, Stephen F & Porter, Richard D, 1981. "The Present-Value Relation: Tests Based on Implied Variance Bounds," Econometrica, Econometric Society, vol. 49(3), pages 555-74, May.
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