The Present Value Model of Us Stock Prices Redux: A New Testing Strategy and Some Evidence

Abstract

Relying on a present value model with time-varying expected returns, and incorporating a quite general class of processes to model bubble like stock price deviations from the long-run equilibrium, we provide empirical evidence on the US log dividend-price ratio over the 1871:1 - 2001:9 period, as well as for several sub-periods. The application of a momentum threshold autoregressive technique designed to detect asymmetric short-run adjustments to the long-run equilibrium provides empirical support in favor of the long-run validity of the present value model. Nevertheless, in the short-run, US stock prices exhibit large and persistent bubble like departures from present value prices followed by a crash.

Keywords: Present Value Model, US Stock Prices, Asymmetric Adjustment, Cointegration

JEL Classification: G12, E44, C32