Fractional integration of expected returns in a present-value model of stock prices

Adam Golinski, Joao Madeira, Dooruj Rambaccussing

    Research output: Chapter in Book/Report/Conference proceedingConference contribution

    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 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.
    Original languageEnglish
    Title of host publicationInternational Association for Applied Econometrics
    PublisherInternational Association for Applied Econometrics
    Number of pages45
    Publication statusPublished - Sep 2014
    EventInternational Association of Applied Econometrics 2014 Annual Conference - Queen Mary University of London, London, United Kingdom
    Duration: 26 Jun 201428 Jun 2014
    http://www.iaae2014.org/

    Conference

    ConferenceInternational Association of Applied Econometrics 2014 Annual Conference
    Abbreviated titleIAAE 2014
    CountryUnited Kingdom
    CityLondon
    Period26/06/1428/06/14
    Internet address

    Keywords

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

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    Rambaccussing, Dooruj

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    Cite this

    Golinski, A., Madeira, J., & Rambaccussing, D. (2014). Fractional integration of expected returns in a present-value model of stock prices. In International Association for Applied Econometrics International Association for Applied Econometrics. http://www.econ.upf.edu/~brossi/IAAE2014Program.pdf