Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?

Abstract

A simple model that is commonly used to interpret movements in corporate common stock. price indexes asserts that real stock prices equal the present value of rationally expected or optimally forecasted future real dividends discounted by a constant real discount rate. This valuation model (or variations on it in which the real discount rate is not constant but fairly stable) is often used by economists and market analysts alike as a plausible model to describe the behavior of aggregate market indexes and is viewed as providing a reasonable story to tell when people ask what accounts for a sudden movement in stock price indexes. Such movements are then attributed to "new information" about future dividends. I will refer to this model as the "efficient markets mode" although it should be recognized that this name has also been applied to other models. It has often been claimed in popular discussions that stock price indexes seem too "volatile," that is, that the movements in stock price indexes could not realistically be attributed to any objective new information, since movements in the price indexes seem to be "too big " relative to actual subsequent events. Recently, the notion that financial asset prices are too volatile to accord with efficient markets has received some econometric support in papers by Stephen LeRoy

Keywords

Affiliated Institutions

• National Bureau of Economic Research US

Related Publications