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Dividend Variability and Stock Market Swings

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  • Martin D.D. Evans

Abstract

This paper examines the extent to which swings in stock prices can be related to variations in the discounted value of expected future dividends when investors face uncertainty about their future behavior. First, I present evidence of instability in time series behavior of dividends and discount rates over the past 120 years and show that it can be well represented by switching processes. I then develop a model for the log dividend-price ratio in which investors rationally anticipate the future switches in the dividend and discount rate processes. Estimates of the model reveal that changing forecasts of future dividend growth account for more than 90% of the predictable variations in dividend-prices. The estimates also imply that process switches contribute significantly to the apparent "excess volatility" of dividend-prices and the predictability of stock returns.

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Bibliographic Info

Paper provided by New York University, Leonard N. Stern School of Business, Department of Economics in its series Working Papers with number 95-13.

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Date of creation: Sep 1995
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Handle: RePEc:ste:nystbu:95-13

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Postal: New York University, Leonard N. Stern School of Business, Department of Economics, 44 West 4th Street, New York, NY 10012-1126
Phone: (212) 998-0860
Fax: (212) 995-4218
Web page: http://w4.stern.nyu.edu/economics/
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Cited by:
  1. Engsted, Tom, 2002. " Measures of Fit for Rational Expectations Models," Journal of Economic Surveys, Wiley Blackwell, vol. 16(3), pages 301-55, July.
  2. Martin D. D. Evans, 2003. "Real risk, inflation risk, and the term structure," Economic Journal, Royal Economic Society, vol. 113(487), pages 345-389, 04.
  3. Gutierrez, Maria-Jose & Vazquez, Jesus, 2004. "Switching equilibria: the present value model for stock prices revisited," Journal of Economic Dynamics and Control, Elsevier, vol. 28(11), pages 2297-2325, October.
  4. Ravi Bansal & A. Ronald Gallant & George Tauchen, 2007. "Rational Pessimism, Rational Exuberance, and Asset Pricing Models," NBER Working Papers 13107, National Bureau of Economic Research, Inc.
  5. Massimiliano De Santis, 2005. "Movements in the Equity Premium: Evidence from a Bayesian Time-Varying VAR," Money Macro and Finance (MMF) Research Group Conference 2005 62, Money Macro and Finance Research Group.
  6. Shively, Philip A., 2007. "Asymmetric temporary and permanent stock-price innovations," Journal of Empirical Finance, Elsevier, vol. 14(1), pages 120-130, January.
  7. Stephen G. Cecchetti & Pok-sang Lam & Nelson C. Mark, 1998. "Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good To Be True?," NBER Working Papers 6354, National Bureau of Economic Research, Inc.
  8. Vázquez Pérez, Jesús & Regúlez Castillo, Marta & Londoño Yarce, Juan Miguel, 2008. "Another Look to the Price-Dividend Ratio: A Markov-Switching Approach," DFAEII Working Papers 2008-09, University of the Basque Country - Department of Foundations of Economic Analysis II.
  9. Rosser, J. Jr. & Ahmed, Ehsan & Hartmann, Georg C., 2003. "Volatility via social flaring," Journal of Economic Behavior & Organization, Elsevier, vol. 50(1), pages 77-87, January.

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