63 Pages Posted: 4 Oct 2018 Last revised: 6 Sep 2019
Date Written: September 6, 2019
We consider an economy in which investors believe dividend growth is predictable, when in reality it is not. We show that these beliefs lead to excess volatility and return predictability. We also show that these beliefs are rational in the face of evidence on dividend growth. We apply this framework to explaining the value premium, predictability of bond returns, and the violation of uncovered interest rate parity.
Keywords: Excess volatility, Extrapolative expectations, Rare events, Overconfidence
JEL Classification: G12, G15, G41
Suggested Citation: Suggested Citation