Cointegration and Tests of Present Value Models

No 1885, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In a model where a variable Y[sub t] is proportional to the present value, with constant discount rate, of expected future values of a variable y[sub t] the "spread" S[sub t]= Y[sub t] - [theta sub t] will be stationary for some [theta] whether or not y[sub t]must be differenced to induce stationarity. Thus, Y[sub t] and y[sub t] are cointegrated. The model implies that S[sub t] is proportional to the optimal forecast of [delta Y{sub t+1}] and also to the optimal forecast of S*[sub t], the present value of future [delta y{sub t}]. We use vector autoregressive methods, and recent literature on cointegrated processes, to test the model. When Y[sub t] is the long-term interest rate and y[sub t] the short-term interest rate, we find in postwar U.S. data that S[sub t] behaves much like an optimal forecast of S*[sub t] even though as earlier research has shown it is negatively correlated with [delta Y{sub t+1}]. When Y[sub t] is a real stock price index and y[sub t] the corresponding real dividend, using annual U.S. data for 1871-1986 we obtain less encouraging results for the model, al-though the results are sensitive to the assumed discount rate.

Date: 1986-04
Note: ME
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Citations: View citations in EconPapers (14)

Published as Campbell, John and Robert J. Shiller. "Cointegration and Tests of Present Value Models," Journal of Political Economy, Vol. 95, No. 5, October 1987, pp. 1062-1088.

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Journal Article: Cointegration and Tests of Present Value Models (1987)
Working Paper: Cointegration and Tests of Present Value Models (1987)
Working Paper: Cointegration and Tests of Present Value Models (1986)
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