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

63 Pages Posted: 13 Oct 2020

See all articles by Davide Delle Monache

Davide Delle Monache

Bank of Italy

Ivan Petrella

University of Warwick; University of Warwick - Finance Group; University of Warwick - Warwick Business School; Centre for Economic Policy Research (CEPR)

Fabrizio Venditti

European Central Bank (ECB)

Multiple version iconThere are 3 versions of this paper

Date Written: September 29, 2020

Abstract

In this paper we develop a general framework to analyse 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: state space models, time-varying parameters, score-driven models, equity premium, present-value models

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

Suggested Citation

Delle Monache, Davide and Petrella, Ivan and Petrella, Ivan and Petrella, Ivan and Venditti, Fabrizio, Price Dividend Ratio and Long-Run Stock Returns: A Score Driven State Space Model (September 29, 2020). Bank of Italy Temi di Discussione (Working Paper) No. 1296, Available at SSRN: https://ssrn.com/abstract=3710125 or http://dx.doi.org/10.2139/ssrn.3710125

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

University of Warwick - Warwick Business School ( email )

Coventry CV4 7AL
United Kingdom

University of Warwick - Finance Group ( email )

Gibbet Hill Rd
Coventry, CV4 7AL
Great Britain

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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