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Learning, Structural Instability and Present Value Calculations

  • Pesaran, M.H.
  • Pettenuzzo, D.
  • Timmermann, A.

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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File URL: http://www.econ.cam.ac.uk/research/repec/cam/pdf/cwpe0602.pdf
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Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0602.

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Length: 33
Date of creation: Jan 2006
Date of revision:
Handle: RePEc:cam:camdae:0602
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Contact details of provider: Web page: http://www.econ.cam.ac.uk/index.htm

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  1. Pesaran, M. Hashem & Timmermann, Allan, 2002. "Market timing and return prediction under model instability," Journal of Empirical Finance, Elsevier, vol. 9(5), pages 495-510, December.
  2. Lubos Pastor & Robert F. Stambaugh, . "The Equity Premium and Structural Breaks," Rodney L. White Center for Financial Research Working Papers 11-00, Wharton School Rodney L. White Center for Financial Research.
  3. Michael P. Clements & David F. Hendry, 2001. "Forecasting Non-Stationary Economic Time Series," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262531895, June.
  4. Pesaran, M Hashem & Pettenuzzo, Davide & Timmermann, Allan G, 2004. "Forecasting Time Series Subject to Multiple Structural Breaks," CEPR Discussion Papers 4636, C.E.P.R. Discussion Papers.
  5. Gary M. Koop & Simon M. Potter, 2004. "Forecasting and Estimating Multiple Change-point Models with an Unknown Number of Change-points," Discussion Papers in Economics 04/31, Department of Economics, University of Leicester.
  6. James H. Stock & Mark W. Watson, 1994. "Evidence on structural instability in macroeconomic times series relations," Working Paper Series, Macroeconomic Issues 94-13, Federal Reserve Bank of Chicago.
  7. René Garcia & Pierre Perron, 1995. "An Analysis of the Real Interest Rate Under Regime Shifts," CIRANO Working Papers 95s-05, CIRANO.
  8. Paye, Bradley S. & Timmermann, Allan, 2006. "Instability of return prediction models," Journal of Empirical Finance, Elsevier, vol. 13(3), pages 274-315, June.
  9. Gary M. Koop & Simon M. Potter, 2004. "Prior elicitation in multiple change-point models," Staff Reports 197, Federal Reserve Bank of New York.
  10. repec:cup:cbooks:9780521634809 is not listed on IDEAS
  11. Timmermann, Allan, 2001. "Structural Breaks, Incomplete Information and Stock Prices," University of California at San Diego, Economics Working Paper Series qt1sn269d7, Department of Economics, UC San Diego.
  12. Clements, Michael P. & Hendry, David F., 1998. "Forecasting economic processes," International Journal of Forecasting, Elsevier, vol. 14(1), pages 111-131, March.
  13. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  14. Chib, Siddhartha, 1998. "Estimation and comparison of multiple change-point models," Journal of Econometrics, Elsevier, vol. 86(2), pages 221-241, June.
  15. Geweke, John, 2001. "A note on some limitations of CRRA utility," Economics Letters, Elsevier, vol. 71(3), pages 341-345, June.
  16. 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.
  17. Timmermann, Allan G, 1993. "How Learning in Financial Markets Generates Excess Volatility and Predictability in Stock Prices," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 1135-45, November.
  18. Robert J. Barro, 2005. "Rare Events and the Equity Premium," NBER Working Papers 11310, National Bureau of Economic Research, Inc.
  19. 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.
  20. David Cass & Menahem E. Yaari, 1965. "Individual Saving, Aggregate Capital Accumulation, and Efficient Growth," Cowles Foundation Discussion Papers 198, Cowles Foundation for Research in Economics, Yale University.
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