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Are stock prices too volatile to be justified by the dividend discount model?

Author

Listed:
  • Akdeniz, Levent
  • Salih, Aslıhan Altay
  • Ok, Süleyman Tuluğ
Abstract
This study investigates excess stock price volatility using the variance bound framework of LeRoy and Porter [The present-value relation: tests based on implied variance bounds, Econometrica 49 (1981) 555–574] and of Shiller [Do stock prices move too much to be justified by subsequent changes in dividends? Am. Econ. Rev. 71 (1981) 421–436.]. The conditional variance bound relationship is examined using cross-sectional data simulated from the general equilibrium asset pricing model of Brock [Asset prices in a production economy, in: J.J. McCall (Ed.), The Economics of Information and Uncertainty, University of Chicago Press, Chicago (for N.B.E.R.), 1982]. Results show that the conditional variance bounds hold, hence, our hypothesis of the validity of the dividend discount model cannot be rejected. Moreover, in our setting, markets are efficient and stock prices are neither affected by herd psychology nor by the outcome of noise trading by naive investors; thus, we are able to control for market efficiency. Consequently, we show that one cannot infer any conclusions about market efficiency from the unconditional variance bounds tests.

Suggested Citation

  • Akdeniz, Levent & Salih, Aslıhan Altay & Ok, Süleyman Tuluğ, 2007. "Are stock prices too volatile to be justified by the dividend discount model?," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 376(C), pages 433-444.
    • Handle: RePEc:eee:phsmap:v:376:y:2007:i:c:p:433-444
    DOI: 10.1016/j.physa.2006.10.097
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    References listed on IDEAS

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    3. Alqahtani, Abdullah & Selmi, Refk & Hongbing, Ouyang, 2021. "The financial impacts of jump processes in the crude oil price: Evidence from G20 countries in the pre- and post-COVID-19," Resources Policy, Elsevier, vol. 72(C).
    4. Zhang, Wei & Zhou, Zhong-Qiang & Xiong, Xiong, 2019. "Behavioral heterogeneity and excess stock price volatility in China," Finance Research Letters, Elsevier, vol. 28(C), pages 348-354.

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