Dundee Discussion Papers in Economics 284: Fractional integration of the price-dividend ratio in a present-value model of stock prices

Adam Golinski, Joao Madeira, Dooruj Rambaccussing

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Abstract

We re-examine the dynamics of returns and dividend growth within the present-value framework of stock prices. We find that the finite sample order of integration of returns is approximately equal to the order of integration of the first-differenced price-dividend ratio. As such, the traditional return fore- casting regressions based on the price-dividend ratio are invalid. Moreover, the nonstationary long memory behaviour of the price-dividend ratio induces antipersistence in returns. This suggests that expected returns should be mod- elled as an ARF IM A process and we show this improves the forecast ability of the present-value model in-sample and out-of-sample.
Original languageEnglish
PublisherUniversity of Dundee
Number of pages45
Publication statusPublished - Feb 2015

Publication series

NameDundee Discussion Papers in Economics
PublisherUniversity of Dundee
No.284
ISSN (Print)1473-236X

Keywords

  • price-dividend ratio
  • persistence
  • fractional integration
  • return predictability
  • present-value model

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