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Price Dividend Ratio and Long-Run Stock Returns: a Score Driven State Space Model

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  • Delle Monache, Davide
  • Petrella, Ivan
  • Venditti, Fabrizio

Abstract

In this paper we develop a general framework to analyze state space models with time-varying system matrices, where time variation is driven by the score of the conditional likelihood. We derive a new filter that allows for the simultaneous estimation of the state vector and of the time-varying matrices. We use this method to study the time-varying relationship between the price dividend ratio, expected stock returns and expected dividend growth in the US since 1880. We find a significant increase in the long-run equilibrium value of the price dividend ratio over time, associated with a fall in the long-run expected rate of return on stocks. The latter can be attributed mainly to a decrease in the natural rate of interest, as the long-run risk premium has only slightly fallen.

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  • Delle Monache, Davide & Petrella, Ivan & Venditti, Fabrizio, 2019. "Price Dividend Ratio and Long-Run Stock Returns: a Score Driven State Space Model," CEPR Discussion Papers 14107, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:14107
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    More about this item

    Keywords

    Equity premium; present-value models; score-driven models; State space models; time-varying parameters;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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