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

Adam Golinski, Joao Madeira () and Dooruj Rambaccussing ()

No 2015-79, SIRE Discussion Papers from Scottish Institute for Research in Economics (SIRE)

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 AFIRMA process and we show this improves the forecast ability of the present-value model in-sample and out-of-sample.

Keywords: price-dividend ratio; persistence; fractional integration; return predictability; present-value model (search for similar items in EconPapers)
Date: 2014-09-12
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