Likelihood-Based Estimation of Exactly-Solved Present-Value Models

49 Pages Posted: 28 Jul 2009 Last revised: 15 Sep 2013

Jules H. van Binsbergen

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Ralph S. J. Koijen

New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR)

Date Written: March 15, 2011

Abstract

We develop a tractable exactly solved present-value model to study the dynamics of stock returns, dividend growth rates, and the price-dividend ratio. We show that standard predictive regressions of returns and dividend growth rates on the lagged price-dividend ratio suffer from a problem that is akin to an errors-in-variables problem. By using non-linear filtering techniques to estimate the structural parameters of our present-value model, we can mitigate this errors-in-variables problem. We then use this framework to decompose the price-dividend ratio and excess stock returns, and study the influence of approximation errors that would arise if we were to log-linearize the model. Our model induces heteroscedasticity in returns, even though the latent processes for expected returns and expected dividend growth rates are homoscedastic.

Suggested Citation

van Binsbergen, Jules H. and Koijen, Ralph S. J., Likelihood-Based Estimation of Exactly-Solved Present-Value Models (March 15, 2011). Available at SSRN: https://ssrn.com/abstract=1439849 or http://dx.doi.org/10.2139/ssrn.1439849

Jules H. Van Binsbergen

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

HOME PAGE: http://www.nber.org/people/jules_vanbinsbergen

Ralph S. J. Koijen (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

HOME PAGE: http://www.koijen.net

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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