Cointegration and Tests of Present Value Models
John Campbell () and
No 785, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University
In a model where a variable Y is proportional to the present value, with constant discount rate, of expected future values of a variable y, the "spread" S - Y - qy will be stationary for some q whether or not y must be differenced to induce stationarity. Thus, Y and y are cointegrated. The model implies that S is proportional to the optimal forecast of S*, the present value of future changes in y. We use vector autoregressive methods, and recent literature on cointegrated processes, to test the model. When Y is the long-term interest rate and y the short-term interest rate, we find in postwar United States data that S behaves much like an optimal forecast of S* even though as earlier research has shown it is negatively correlated with next period's change in Y. When Y is a real stock price index and y the corresponding real dividend, using annual United States data for 1871-1986 we obtain less encouraging results for the model, although the results are sensitive to the assumed discount rate.
Keywords: Cointegration; present value methods; stock price index; interest rates; term structure; volatility; efficient markets (search for similar items in EconPapers)
References: Add references at CitEc
Citations: View citations in EconPapers (6) Track citations by RSS feed
Published in Journal of Political Economy (October 1987), 95: 1062-1088; also in Robert F. Engle and Clive W.J. Granger (eds.), Long-Run Economic Relationships: Readings in Cointegration, Oxford University Press, 1991, pp. 191-217; and Andrew W. Lo (ed.), Financial Econometrics, Edward Elgar, 2005
Downloads: (external link)
Journal Article: Cointegration and Tests of Present Value Models (1987)
Working Paper: Cointegration and Tests of Present Value Models (1987)
Working Paper: Cointegration and Tests of Present Value Models (1986)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:cwl:cwldpp:785
Ordering information: This working paper can be ordered from
Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA
The price is None.
Access Statistics for this paper
More papers in Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University Yale University, Box 208281, New Haven, CT 06520-8281 USA. Contact information at EDIRC.
Bibliographic data for series maintained by Matthew Regan ().