New Evidence for the Present-Value Model of Stock Prices: Why the REH Version Failed Empirically

45 Pages Posted: 27 Mar 2015

See all articles by Roman Frydman

Roman Frydman

New York University (NYU) - Department of Economics

Michael D. Goldberg

University of New Hampshire

Nicholas Mangee

Armstrong Atlantic State University

Date Written: February 2, 2015

Abstract

Shiller (1981) and others have shown that the quantitative predictions of the REH present-value model are inconsistent with time-series data on stock prices and dividends. In this paper, we assess the empirical relevance of the model without explicitly representing how a rational market participant forecasts dividends and interest rates. We find that stock prices are driven largely by news about fundamental factors. Moreover, this news moves prices through changes in the market’s forecasts of dividends and/or interest rates in ways that are remarkably consistent with the present-value model. We also find that the structure of the process underpinning stock prices undergoes quantitative change, and that both fundamental and psychological factors play an important role in this process. Taken together, Shiller’s findings and ours point to a novel explanation of the present-value model’s empirical difficulties. They also imply that macroeconomists and finance theorists should rethink how to represent rational forecasting in real-world markets.

JEL Classification: E44, G12, G14

Suggested Citation

Frydman, Roman and Goldberg, Michael D. and Mangee, Nicholas, New Evidence for the Present-Value Model of Stock Prices: Why the REH Version Failed Empirically (February 2, 2015). Institute for New Economic Thinking Working Paper Series No. 2. Available at SSRN: https://ssrn.com/abstract=2585690 or http://dx.doi.org/10.2139/ssrn.2585690

Roman Frydman (Contact Author)

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

19 West 4th Street
New York, NY 10012
United States

Michael D. Goldberg

University of New Hampshire ( email )

Durham, NH 03824
United States
603-862-3385 (Phone)
603-862-3383 (Fax)

HOME PAGE: http://pubpages.unh.edu/~michaelg/

Nicholas Mangee

Armstrong Atlantic State University ( email )

11935 Abercorn Street
Savannah, GA 31419
United States

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