Stock Prices, Earnings and Expected Dividends

42 Pages Posted: 14 Jan 2001  

John Y. Campbell

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Robert J. Shiller

Yale University - Cowles Foundation; National Bureau of Economic Research (NBER); Yale University - International Center for Finance

Date Written: February 1988

Abstract

This paper presents estimates indicating that, for aggregate U.S. stock market data 1871-1986, a long historical average of real earnings is a good predictor of the present value of future real dividends. This is true even when the information contained in stock prices is taken into account. We estimate that for each year the optimal forecast of the present value of future real dividends is roughly a weighted average of moving average earnings and current real price, with between 2/3 and 3/4 of the weight on the earnings measure. This means that simple present value models of stock prices can be strongly rejected. We use a vector autoregressive approach which enables us to compute the implications of this for the behavior of stock prices and returns. We estimate that log dividend-price ratios are more variable than, and virtually uncorrelated with, their theoretical counterparts given the present value models. Annual returns on stocks are quite highly correlated with their theoretical counterparts, but are two to four times as variable. Our approach also reveals the connection between recent papers showing forecastability of long-horizon returns on corporate stocks, and earlier literature claiming that stock prices are too volatile to be accounted for in terms of simple present value models. We show that excess volatility directly implies the forecastability of long-horizon returns.

Suggested Citation

Campbell, John Y. and Shiller, Robert J., Stock Prices, Earnings and Expected Dividends (February 1988). NBER Working Paper No. w2511. Available at SSRN: https://ssrn.com/abstract=246866

John Y. Campbell (Contact Author)

Harvard University - Department of Economics ( email )

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HOME PAGE: http://scholar.harvard.edu/campbell

National Bureau of Economic Research (NBER)

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Robert J. Shiller

National Bureau of Economic Research (NBER) ( email )

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Yale University - International Center for Finance ( email )

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203-432-6167 (Fax)

Yale University - Cowles Foundation ( email )

Box 208281
New Haven, CT 06520-8281
United States
203-432-3708 (Phone)
203-432-6167 (Fax)

HOME PAGE: http://www.econ.yale.edu/~shiller/

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