On the Present Value Model in a Cross Section of Stocks

38 Pages Posted: 1 Apr 2014

See all articles by Richard Startz

Richard Startz


Kwok Ping Tsang

Virginia Polytechnic Institute & State University

Date Written: March 31, 2014


We construct a cross-section of stock prices and their corresponding present values of future cash flows. A regression of present value on the initial stock price should have a slope coefficient equal to 1.0. For short horizons, this is a cross-section version of checking the random walk model and the present value model holds up well. In contrast, using three different samples that go as far back as 1926, the present value model is rejected decisively at moderate and long horizons. We can rule out the possibility that the failure of the present value relationship is due to a misunderstanding of the dividend process. The remaining possibilities are either that agents do not discount very far into the future in a manner consistent with the present value model, or that models of discount rates are too limited to allow the present value model to be a good fit to the data for most firms. We find that the present value works much better, albeit still imperfectly, for larger firms. We also find that stocks that appear on the exchanges for fewer years than longer-lasting stocks deviate even more from the present value model. Our results can be interpreted as a cross-section version of the variance-bounds test, with the result that prices are very much more variable than they ought to be.

Keywords: present value model, stock price, discount rate

JEL Classification: G11, G17

Suggested Citation

Startz, Richard and Tsang, Kwok Ping, On the Present Value Model in a Cross Section of Stocks (March 31, 2014). Available at SSRN: https://ssrn.com/abstract=2418452 or http://dx.doi.org/10.2139/ssrn.2418452

Richard Startz

UCSB ( email )

Department of Economics
University of California
Santa Barbara, CA 93106-9210
United States
805-893-2895 (Phone)

Kwok Ping Tsang (Contact Author)

Virginia Polytechnic Institute & State University ( email )

250 Drillfield Drive
Blacksburg, VA 24061
United States

HOME PAGE: http://https://sites.google.com/site/byrontkp/

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