Working Paper: NBER ID: w10263
Authors: John Y. Campbell; Tuomo Vuolteenaho
Abstract: We empirically decompose the S&P 500's dividend yield into (1) a rational forecast of long-run real dividend growth, (2) the subjectively expected risk premium, and (3) residual mispricing attributed to the market's forecast of dividend growth deviating from the rational forecast. Modigliani and Cohn's (1979) hypothesis and the persistent use of the Fed model' by Wall Street suggest that the stock market incorrectly extrapolates past nominal growth rates without taking into account the impact of time-varying inflation. Consistent with the Modigliani-Cohn hypothesis, we find that the level of inflation explains almost 80% of the time-series variation in stock-market mispricing.
Keywords: No keywords provided
JEL Codes: G12; G14; N22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| mispricing in the stock market (G10) | rational valuation of stocks (G12) |
| high inflation (E31) | underpricing of stocks (G10) |
| inflation influences investors' subjective growth forecasts (E31) | mispricing in the stock market (G10) |
| inflation (E31) | nominal dividend growth expectations (G35) |
| subjective risk premium (D81) | inflation (E31) |
| high inflation (E31) | mispricing in the stock market (G10) |