Price Dividend Ratio and Long-Run Stock Returns: A Score Driven State Space Model

69 Pages Posted: 4 Dec 2019

See all articles by Davide Delle Monache

Davide Delle Monache

Bank of Italy

Ivan Petrella

University of Warwick; Centre for Economic Policy Research (CEPR)

Fabrizio Venditti

European Central Bank (ECB)

Multiple version iconThere are 2 versions of this paper

Date Written: November 2019

Abstract

In this paper we develop a general framework to analyze state space models with time-varying system matrices, where time variation is driven by the score of the conditional likelihood. We derive a new filter that allows for the simultaneous estimation of the state vector and of the time-varying matrices. We use this method to study the time-varying relationship between the price dividend ratio, expected stock returns and expected dividend growth in the US since 1880. We find a significant increase in the long-run equilibrium value of the price dividend ratio over time, associated with a fall in the long-run expected rate of return on stocks. The latter can be attributed mainly to a decrease in the natural rate of interest, as the long-run risk premium has only slightly fallen.

Keywords: Equity premium, present-value models, score-driven models, State space models, time-varying parameters

JEL Classification: C32, C51, C53, E44, G12

Suggested Citation

Delle Monache, Davide and Petrella, Ivan and Venditti, Fabrizio, Price Dividend Ratio and Long-Run Stock Returns: A Score Driven State Space Model (November 2019). CEPR Discussion Paper No. DP14107. Available at SSRN: https://ssrn.com/abstract=3496596

Davide Delle Monache (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Ivan Petrella

University of Warwick ( email )

Gibbet Hill Rd.
Coventry, West Midlands CV4 8UW
United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Fabrizio Venditti

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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