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Long Swings with Memory and Stock Market Fluctuations

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  • Chow, Ying-Foon
  • Liu, Ming

Abstract

It is now widely held that stock prices are too volatile to be optimal forecasts of future dividends discounted at a constant rate. Using the present value model with a constant discount rate, we show that when there is memory in the duration of dividend swings, the stock price can move in a more volatile fashion than could be warranted by future dividend movements. The memory in the duration of a dividend swing will lead economic agents to time the swing, thereby generating a spurious bias in the stock price. When memory is strong, this spurious bias becomes significant and induces excess volatility in the stock price as if rational bubbles exist. The Efficient Method of Moments (EMM) procedure is used to examine the long swings property in the dividend series. We cannot reject the hypothesis of a strong memory in the dividend swings, and show that excess volatility, even in large samples, can be generated through simulation.

Suggested Citation

  • Chow, Ying-Foon & Liu, Ming, 1999. "Long Swings with Memory and Stock Market Fluctuations," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 34(03), pages 341-367, September.
  • Handle: RePEc:cup:jfinqa:v:34:y:1999:i:03:p:341-367_00
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    Cited by:

    1. Zhong, Maosen & Darrat, Ali F. & Anderson, Dwight C., 2003. "Do US stock prices deviate from their fundamental values? Some new evidence," Journal of Banking & Finance, Elsevier, vol. 27(4), pages 673-697, April.
    2. Leonardo Becchetti & Roberto Rocci & Giovanni Trovato, 2007. "Industry and time specific deviations from fundamental values in a random coefficient model," Annals of Finance, Springer, pages 257-276.
    3. Samih Antoine Azar, 2004. "Excess volatility in the US stock market: evidence to the contrary," Applied Financial Economics, Taylor & Francis Journals, pages 1307-1311.
    4. Leipus, Remigijus & Paulauskas, Vygantas & Surgailis, Donatas, 2005. "Renewal regime switching and stable limit laws," Journal of Econometrics, Elsevier, vol. 129(1-2), pages 299-327.

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