The present value model of US stock prices revisited: long-run evidence with structural breaks, 1871-2010

Abstract

According to several empirical studies, the Present Value model fails to explain the behavior of stock prices in the long-run. In this paper we consider the possibility that a linear co integrated regression model with multiple structural changes would provide a better empirical description of the Present Value model of u.S. stock prices. Our methodology is based on instability tests recently proposed in Kejriwal and Perron (2008, 2010) as well as the cointegration tests developed in Arai and Kurozumi (2007) and Kejriwal (2008). The results obtained are consistent with the existence of linear cointegration between the log stock prices and the log dividends. However, our empirical results also show that the cointegrating relationship has changed over time. In particular, the Kejriwal-Perron tests for testing multiple structural breaks in co integrated regression models suggest a model of three or two regimes