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Stock Price Booms and Expected Capital Gains

Author

Listed:
  • Klaus Adam
  • Albert Marcet
  • Johannes Beutel
Abstract
The booms and busts in U.S. stock prices over the post-war period can to a large extent be explained by fluctuations in investors' subjective capital gains expectations. Survey measures of these expectations display excessive optimism at market peaks and excessive pessimism at market troughs. Formally incorporating subjective price beliefs into an otherwise standard asset pricing model with utility maximizing investors, we show how subjective belief dynamics can temporarily delink stock prices from their fundamental value and give rise to asset price booms that ultimately result in a price bust. The model quantitatively replicates (1) the volatility of stock prices and (2) the positive correlation between the price dividend ratio and expected returns observed in survey data. We show that models imposing objective or 'rational' price expectations cannot simultaneously account for both facts. Our findings imply that large parts of U.S. stock price fluctuations are not due to standard fundamental forces, instead result from self-reinforcing belief dynamics triggered by these fundamentals.

Suggested Citation

  • Klaus Adam & Albert Marcet & Johannes Beutel, 2015. "Stock Price Booms and Expected Capital Gains," Working Papers 757, Barcelona School of Economics.
  • Handle: RePEc:bge:wpaper:757
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    References listed on IDEAS

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    More about this item

    Keywords

    Stock Price Volatility; learning; survey expectations; internal rationality;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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    1. Stock Price Booms and Expected Capital Gains? (Barcelona GSE WP 2015) in ReplicationWiki

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