Valuing Equity when Discounted Cash Flows are Markov

Jeremy Berkowitz

Chapter 1 in Nonlinear Financial Econometrics: Markov Switching Models, Persistence and Nonlinear Cointegration, 2011, pp 3-20 from Palgrave Macmillan

Abstract: Abstract In the absence of arbitrage opportunities, the value of a claim that is expected to pay a stream of payments d t is equal to its discounted expected cash flow. This result is a consequence of the martingale representation established in Harrison and Kreps (1979) and Harrison, Pliska (1981). Yet for valuing stocks, no formal methods of implementing the present value model are in widespread use. A great deal of attention has been focused on valuing individual equities cross-sectionally from a small set of factors. The CAPM, the Consumption-based CAPM and the APT are all models in which asset price risk and hence return are driven by a small number of state variables. These models have been subject to countless empirical investigations and have generally been rejected for US equity and bond returns (e.g., Hansen and Singleton (1982), Gibbons, Ross and Shanken (1989), Hansen and Jagannathan (1991), Ferson and Harvey (1992)).

Keywords: Stock Price; Stock Return; Asset Price; Markov Property; Arbitrage Opportunity (search for similar items in EconPapers)
Date: 2011
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Persistent link: https://EconPapers.repec.org/RePEc:pal:palchp:978-0-230-29521-6_1

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DOI: 10.1057/9780230295216_1

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