Stock price booms and expected capital gains


Adam, Klaus ; Beutel, Johannes ; Marcet, Albert


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URL: https://ub-madoc.bib.uni-mannheim.de/36176
URN: urn:nbn:de:bsz:180-madoc-361760
Document Type: Working paper
Year of publication: 2014
The title of a journal, publication series: Working Paper Series
Volume: 14-12
Place of publication: Mannheim
Publication language: English
Institution: School of Law and Economics > Geldpolitik und Makroökonomik (Adam 2008-)
Außerfakultäre Einrichtungen > Graduate School of Economic and Social Sciences - CDSE (Economics)
MADOC publication series: Department of Economics > Working Paper Series
Subject: 330 Economics
Classification: JEL: G12 , D84,
Abstract: The booms and busts in U.S. stock prices over the post-war period can to a large extent be explained by fluctuations in investors` subjective capital gains expectations. Survey measures of these expectations display excessive optimism at market peaks and excessive pessimism at market throughs. Formally incorporating subjective price beliefs into an otherwise standard asset pricing model with utility maximizing investors, we show how subjective belief dynamics can temporarily delink stock prices from their fundamental value and give rise to asset price booms that ultimately result in a price bust. The model successfully replicates (1) the volatility of stock prices and (2) the positive correlation between the price dividend ratio and expected returns observed in survey data. We show that models imposing objective or `rational` price expectations cannot simultaneously account for both facts. Our findings imply that large parts of U.S. stock price fluctuations are not due to standard fundamental forces, instead result from self-reinforcing belief dynamics triggered by these fundamentals.




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