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 forecasting 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 modelled as an ARFIMA process and we show this improves the forecast ability of the present-value model in-sample and out-of-sample.
|Title of host publication||International Association for Applied Econometrics|
|Publisher||International Association for Applied Econometrics|
|Number of pages||45|
|Publication status||Published - Sept 2014|
|Event||International Association of Applied Econometrics 2014 Annual Conference - Queen Mary University of London, London, United Kingdom|
Duration: 26 Jun 2014 → 28 Jun 2014
|Conference||International Association of Applied Econometrics 2014 Annual Conference|
|Abbreviated title||IAAE 2014|
|Period||26/06/14 → 28/06/14|
- price-dividend ratio
- fractional integration
- return predictability
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- University of Dundee School of Business - Senior Lecturer (Teaching and Research)