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      Are stock prices too volatile to be justified by the dividend discount model?

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      Author(s)
      Akdeniz, L.
      Salih, A. A.
      Ok, S. T.
      Date
      2007
      Source Title
      Physica A: Statistical Mechanics and its Applications
      Print ISSN
      0378-4371
      Electronic ISSN
      1873-2119
      Publisher
      Elsevier
      Volume
      376
      Pages
      433 - 444
      Language
      English
      Type
      Article
      Item Usage Stats
      225
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      349
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      Abstract
      This study investigates excess stock price volatility using the variance bound framework of LeRoy and Porter [The present-value relation: tests based on implied variance bounds, Econometrica 49 (1981) 555-574] and of Shiller [Do stock prices move too much to be justified by subsequent changes in dividends? Am. Econ. Rev. 71 (1981) 421-436.]. The conditional variance bound relationship is examined using cross-sectional data simulated from the general equilibrium asset pricing model of Brock [Asset prices in a production economy, in: J.J. McCall (Ed.), The Economics of Information and Uncertainty, University of Chicago Press, Chicago (for N.B.E.R.), 1982]. Results show that the conditional variance bounds hold, hence, our hypothesis of the validity of the dividend discount model cannot be rejected. Moreover, in our setting, markets are efficient and stock prices are neither affected by herd psychology nor by the outcome of noise trading by naive investors; thus, we are able to control for market efficiency. Consequently, we show that one cannot infer any conclusions about market efficiency from the unconditional variance bounds tests.
      Keywords
      Asset pricing
      Dividend discount model
      Excess volatility
      Market efficiency
      Variance bounds
      Computational complexity
      Computer simulation
      Data reduction
      Marketing
      Mathematical models
      Statistical methods
      Economics
      Permalink
      http://hdl.handle.net/11693/23516
      Published Version (Please cite this version)
      http://dx.doi.org/10.1016/j.physa.2006.10.097
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