Hostname: page-component-78c5997874-xbtfd Total loading time: 0 Render date: 2024-11-05T12:02:37.216Z Has data issue: false hasContentIssue false
  • English
  • Français

Long Swings with Memory and Stock Market Fluctuations

Published online by Cambridge University Press:  06 April 2009

Ying-Foon Chow  and
Ming Liu
Ying-Foon Chow
Affiliation:
Department of Finance, Chinese University of Hong Kong, Shatin, New Territories, Hong Kong.
Ming Liu
Affiliation:
Department of Finance, Chinese University of Hong Kong, Shatin, New Territories, Hong Kong.
Get access Rights & Permissions [Opens in a new window]

Abstract

It is now widely held that stock prices are too volatile to be optimal forecasts of future dividends discounted at a constant rate. Using the present value model with a constant discount rate, we show that when there is memory in the duration of dividend swings, the stock price can move in a more volatile fashion than could be warranted by future dividend movements. The memory in the duration of a dividend swing will lead economic agents to time the swing, thereby generating a spurious bias in the stock price. When memory is strong, this spurious bias becomes significant and induces excess volatility in the stock price as if rational bubbles exist. The Efficient Method of Moments (EMM) procedure is used to examine the long swings property in the dividend series. We cannot reject the hypothesis of a strong memory in the dividend swings, and show that excess volatility, even in large samples, can be generated through simulation.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 34 , Issue 3 , September 1999 , pp. 341 - 367
Copyright
Copyright © School of Business Administration, University of Washington 1999

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Abel, A. B. “Exact Solutions for Expected Rates of Return under Markov Regime Switching: Implications for the Equity Premium Puzzle” Journal of Money, Credit and Banking, 26 (08 1994), 345–361.Google Scholar
Akaike, H. “Information Theory and an Extension of the Maximum Likelihood Principle.” In 2nd International Symposium on Information Theory, Petrov, B. N. and Csáki, F., eds. Akadémiai Kiadó, Budapest (1973), 267–281.Google Scholar
Allen, F., and Gale, D.. “Limited Market Participation and Volatility of Asset Prices” American Economic Review, 84 (09 1994), 933–955.Google Scholar
Bansal, R.; Gallant, A. R.; Hussey, R.; and Tauchen, G.. “Nonparametric Estimation of Structural Models for High-Frequency Currency Market Data.” Journal of Econometrics, 66 (03–04 1995), 251–287.Google Scholar
Barsky, R. B., and De Long, J. B.. “Why Does the Stock Market Fluctuate?” Quarterly Journal of Economics, 108 (05 1993), 291–311.Google Scholar
Boldrin, M.; Christiano, L. J.; and Fisher, J. D. M.. “Asset Pricing Lessons for Modeling Business Cycles.” Working Paper 5262, NBER (09 1995).CrossRefGoogle Scholar
Brennan, M. J., and Xia, Y.. “Stock Price Volatility, Learning, and the Equity Premium.” Working Paper, Anderson School at UCLA (02 1998).Google Scholar
Brown, S. J.; Goetzmann, W. N.; and Ross, S. A.. “Survival.” Journal of Finance, 50 (07 1995), 853–873.Google Scholar
Campbell, J. Y. “Asset Prices, Consumption, and the Business Cycle.” Working Paper 6485, NBER (09 1998).Google Scholar
Campbell, J. Y., and Kyle, A. S.. “Smart Money, Noise Trading and Stock Price Behaviour” Review of Economic Studies, 60 (01 1993), 1–34.CrossRefGoogle Scholar
Campbell, J. Y., and Shiller, R. J.. “The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors.” Review of Financial Studies, 1 (Fall 1988), 195–228.Google Scholar
Campbell, J. Y.; Lo, A. W.; and MacKinlay, A. C.. The Econometrics of Financial Markets. Princeton, NJ: Princeton Univ. Press (1997).Google Scholar
Cecchetti, S. G.; Lam, P. S.; and Mark, N. C.. “The Equity Premium and the Risk-Free Rate: Matching the Moments” Journal of Monetary Economics, 31 (02 1993), 21–45.Google Scholar
De Long, J. B.; Shleifer, A.; Summers, L. H.; and Waldmann, R. J.. “Noise Trader Risk in Financial Markets” Journal of Political Economy, 98 (08 1990), 703–738.CrossRefGoogle Scholar
Diebold, F. X.; Rudebusch, G. D.; and Sichel, D. E.. “Further Evidence on Business Cycle Duration Dependence.” In Business Cycles, Indicators and Forecasting, Stock, J. H. and Watson, M. W. eds. Chicago, IL: Univ. of Chicago Press (1993).Google Scholar
Donaldson, R. G., and Kamstra, M.. “A New Dividend Forecasting Procedure that Rejects Bubbles in Asset Prices: The Case of 1929's Stock Crash.” Review of Financial Studies, 9 (Summer 1996), 333–383.Google Scholar
Evans, M. D. D. “Dividend Variability and Stock Market Swings” Review of Economic Studies, 65 (10 1998), 711–740.Google Scholar
Fama, E. F., and French, K. R.. “Dividend Yields and Expected Stock Returns” Journal of Financial Economics, 22 (10 1988), 3–25.Google Scholar
Fama, E. F., and French, K. R.. “Business Conditions and Expected Returns on Stocks and Bonds” Journal of Financial Economics, 25 (11 1989), 23–49.Google Scholar
Flood, R. P., and Hodrick, R. J.. “Asset Price Volatility, Bubbles, and Process Switching” Journal of Finance, 41 (09 1986), 831–842.CrossRefGoogle Scholar
Gallant, A. R., and Long, J. R.. “Estimating Stochastic Differential Equations Efficiently by Minimum Chi-Square, Biometrika, 84 (03 1997), 125–141.CrossRefGoogle Scholar
Gallant, A. R., and Tauchen, G.. “Semi-Nonparametric Estimation of Conditionally Constrained Heterogeneous Processes: Asset Pricing Applications” Econometrica, 57 (09 1989), 1091–1120.CrossRefGoogle Scholar
Gallant, A. R., and Tauchen, G.. “Which Moment to Match?” Econometric Theory, 12 (10 1996), 657–681.Google Scholar
Gallant, A. R.; Rossi, P. E.; and Tauchen, G.. “Stock Prices and Volume.” Review of Financial Studies, 5 (Summer 1992), 199–242.Google Scholar
Gallant, A. R.; Rossi, P. E.; and Tauchen, G.. “Nonlinear Dynamic Structures.” Econometrica, 61 (07 1993), 871–907.CrossRefGoogle Scholar
Gilles, C., and LeRoy, S. F.. “Econometric Aspects of the Variance Bounds Tests: A Survey.” Review of Financial Studies, 4 (Winter 1991), 753–791.Google Scholar
Goetzmann, W. N., and Jorion, P.. “Testing the Predictive Power of Dividend Yields.” Journal of Finance, 48 (07 1993), 663–679.Google Scholar
Goetzmann, W. N., and Jorion, P.. “A Longer Look at Dividend Yields” Journal of Business, 68 (10 1995), 483–508.Google Scholar
Hamilton, J. D. “A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle.” Econometrica, 57 (03 1989), 357–384.Google Scholar
Kandel, S., and Stambaugh, R. F.. “Expectations and Volatility of Consumption and Asset Returns.” Review of Financial Studies, 3 (Summer 1990), 207–232.Google Scholar
Lee, B. S. “The Response of Stock Prices to Permanent and Temporary Shocks to Dividends.” Journal of Financial and Quantitative Analysis, 30 (03 1995), 1–22.Google Scholar
LeRoy, S. F., and Parke, W.. “Stock Price Volatility: Tests Based on the Geometric Random Walk” American Economic Review, 82 (09 1992), 981–992.Google Scholar
LeRoy, S. F., and Porter, R.. “The Present-Value Relation: Tests Based on Implied Variance Bounds.” Econometrica, 49 (05 1981), 555–574.Google Scholar
Mehra, R., and Prescott, E. C.. “The Equity Premium Puzzle.” Journal of Monetary Economics, 15 (03 1985), 145–161.CrossRefGoogle Scholar
Romer, D. “Rational Asset-Price Movements without News” American Economic Review, 83 (12 1993), 1112–1130.Google Scholar
Schwarz, G. “Estimating the Dimension of a Model.” Annals of Statistics, 6 (03 1978), 461–464.Google Scholar
Schwert, G. W. “Why Does Stock Market Volatility Change over Time?” Journal of Finance, 44 (12 1989), 1115–1153.CrossRefGoogle Scholar
Shiller, R. J. “Do Stock Prices Move Too Much to Be Justified by Subsequent Changes in Dividends?” American Economic Review, 71 (06 1981), 421–436.Google Scholar
Shiller, R. J. “Stock Prices and Social Dynamics.” Brookings Papers on Economic Activity (1984), 457–498.Google Scholar
Shiller, R. J.Market Volatility. Cambridge, MA: MIT Press (1989).Google Scholar
Spiegel, M. “Stock Price Volatility in a Multiple Security Overlapping Generations Model.” Review of Financial Studies, 11 (Summer 1998), 419–447.CrossRefGoogle Scholar
Timmermann, A. “How Learning in Financial Markets Generates Excess Volatility and Predictability in Stock Prices” Quarterly Journal of Economics, 108 (11 1993), 1135–1145.CrossRefGoogle Scholar
Timmermann, A. “Excess Volatility and Predictability of Stock Prices in Autoregressive Dividend Models with Learning, Review of Economic Studies, 63 (10 1996), 523–557.Google Scholar
Weil, P. “The Equity Premium Puzzle and the Risk-Free Rate Puzzle” Journal of Monetary Economics, 24 (11 1989), 401–421.CrossRefGoogle Scholar
West, K. D. “Bubbles, Fads and Stock Price Volatility Tests: A Partial View.” Journal of Finance, 43 (07 1988), 639–656.Google Scholar