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Learning, structural instability and present value calculations

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Author Info
Pesaran, Hashem
Pettenuzzo, Davide
Timmermann, Allan

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Abstract

Present value calculations require predictions of cash flows both at near and distant future points in time. Such predictions are generally surrounded by considerable uncertainty and may critically depend on assumptions about parameter values as well as the form and stability of the data generating process underlying the cash flows. This paper presents new theoretical results for the existence of the infinite sum of discounted expected future values under uncertainty about the parameters characterizing the growth rate of the cash flow process. Furthermore, we explore the consequences for present values of relaxing the stability assumption in a way that allows for past and future breaks to the underlying cash flow process. We find that such breaks can lead to considerable changes in present values. --

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Publisher Info
Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 1: Economic Studies with number 2006,27.

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Date of creation: 2006
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Handle: RePEc:zbw:bubdp1:4756

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Related research
Keywords: present value; stock prices; structural breaks; Bayesian learning;

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Find related papers by JEL classification:
G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Bayesian Analysis

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  2. Paye, Bradley S. & Timmermann, Allan, 2006. "Instability of return prediction models," Journal of Empirical Finance, Elsevier, vol. 13(3), pages 274-315, June. [Downloadable!] (restricted)
  3. Pesaran, M.H. & Pettenuzzo, D. & Timmermann, A., 2004. "‘Forecasting Time Series Subject to Multiple Structural Breaks’," Cambridge Working Papers in Economics 0433, Faculty of Economics, University of Cambridge. [Downloadable!]
    Other versions:
  4. Alogoskoufis, George S & Smith, Ron, 1991. "The Phillips Curve, the Persistence of Inflation, and the Lucas Critique: Evidence from Exchange-Rate Regimes," American Economic Review, American Economic Association, vol. 81(5), pages 1254-75, December. [Downloadable!] (restricted)
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  7. Chib, Siddhartha, 1998. "Estimation and comparison of multiple change-point models," Journal of Econometrics, Elsevier, vol. 86(2), pages 221-241, June. [Downloadable!] (restricted)
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  9. Banerjee, Anindya & Lumsdaine, Robin L & Stock, James H, 1992. "Recursive and Sequential Tests of the Unit-Root and Trend-Break Hypotheses: Theory and International Evidence," Journal of Business & Economic Statistics, American Statistical Association, vol. 10(3), pages 271-87, July.
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