Fractional Integration of the Price-Dividend Ratio in a Present-Value Model.

Golinski, Adam and Madeira, Joao and Rambaccussing, Dooruj (2014): Fractional Integration of the Price-Dividend Ratio in a Present-Value Model.

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.

• Item Type: MPRA Paper
• Language: English
• Keywords: price-dividend ratio, persistence, fractional integration, return predictability, present-value model.
• Subjects: C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C32 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes ; State Space Models; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C58 - Financial Econometrics; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates

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