Bubbles in the dividend-price ratio? Evidence from an asymmetric exponential smooth-transition model

Citation

McMillan D (2007) Bubbles in the dividend-price ratio? Evidence from an asymmetric exponential smooth-transition model. Journal of Banking and Finance, 31 (3), pp. 787-804. https://doi.org/10.1016/j.jbankfin.2006.02.006

Abstract
Recent stock price movements have led to a re-examination of the present value model. An increasing belief is that although dividends and prices are indeed cointegrated, they may exhibit non-linear dynamics in the process of reversion. This paper implements an empirical model designed to capture two possible explanations for such non-linearity, namely transaction costs and noise traders. Utilising data from a number of countries we show that the dynamics of the log dividend yield are, first, characterised by an inner random walk regime, where the benefits of engaging in trade do not outweigh the costs and so the process moves randomly. Second, a reverting outer regime where the dynamics of reversion differ between positive and negative deviations, such that price rises greater than the level supported by dividends exhibit a greater degree of persistence than price falls relative to dividends.

Keywords
stock market dynamics; present value model; asymmetric-ESTR model; behavioural finance

Journal
Journal of Banking and Finance: Volume 31, Issue 3

People

Professor David McMillan

Professor in Finance, Accounting & Finance