A Note on Return Predictability and Price Bubbles

Abstract

In this paper, we use a stylized but relatively flexible structural model to describe return predictability and we derive its implications for the second moments of return and dividend-yield innovations. These implications have equivalent representations as alternative sets of reduced form equations if prices are the discounted present value of the future dividend stream. We exploit this fact to infer the presence of a bubble component in stock prices.

Keywords: bubbles, equity risk premium, predictability

JEL Classification: C32, G12, G14