Knightian uncertainty and stock-price movements: Why the REH present-value model failed empirically

Roman Frydman, Michael D. Goldberg and Nicholas Mangee

Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), 2015, vol. 9, No 2015-24, 50 pages

Abstract: Macroeconomic models that are based on either the rational expectations hypothesis (REH) or behavioral considerations share a core premise: All future market outcomes can be characterized ex ante with a single overarching probability distribution. This paper assesses the empirical relevance of this premise using a novel data set. The authors find that Knightian uncertainty, which cannot be reduced to a probability distribution, underpins outcomes in the stock market. This finding reveals the full implications of Robert Shiller's ground-breaking rejection of the class of REH present-value models that rely on the consumption-based specification of the risk premium. The relevance of Knightian uncertainty is inconsistent with all REH models, regardless of how they specify the market's risk premium. The authors' evidence is also inconsistent with bubble accounts of REH models' empirical difficulties. They consider a present-value model based on a New Rational Expectations Hypothesis, which recognizes the relevance of Knightian uncertainty in driving outcomes in real-world markets. Their novel data is supportive of the model's implications that rational forecasting relies on both fundamental and psychological factors.

Keywords: Knightian uncertainty; structural change; fundamentals; psychology; presentvalue model; stock prices (search for similar items in EconPapers)
JEL-codes: B40 E44 G12 G14 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

Downloads: (external link)
http://dx.doi.org/10.5018/economics-ejournal.ja.2015-24
https://www.econstor.eu/bitstream/10419/114622/1/833517821.pdf (application/pdf)

Related works:
Working Paper: Knightian uncertainty and stock-price movements: Why the REH present-value model failed empirically (2015)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:zbw:ifweej:201524

DOI: 10.5018/economics-ejournal.ja.2015-24

Access Statistics for this article

Economics - The Open-Access, Open-Assessment E-Journal (2007-2020) is currently edited by Dennis J. Snower

More articles in Economics - The Open-Access, Open-Assessment E-Journal (2007-2020) from Kiel Institute for the World Economy (IfW Kiel) Contact information at EDIRC.
Bibliographic data for series maintained by ZBW - Leibniz Information Centre for Economics (econstor@zbw-workspace.eu).