Abstract: This paper compares the predictions for the market value of firms from
the Gordon growth model with those from a dynamic general equilibrium
model of production. The predictions for movements in the market
value of firms in response to a decline in the required return or an
increase in the growth rate of the economy are quantitatively and
qualitatively different across the models. While previous research
has illustrated how a drop in the required return or an increase in
the growth rate of the economy can explain the runup in equity values
in the 1990s in the Gordon growth model, the consideration of
production overturns these results and illustrates that auxiliary
implications of such shifts in fundamentals, such as a sharp increase
in the investment intensity of the economy, are not supported by the
data in the late 1990s. This tension between theory and data suggests
that the skyrocketing market value of firms in the second half of the
1990s may reflect a degree of irrational exuberance.
Keywords: Asset pricing, investment
Full paper (108 KB PDF)
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Last update: March 10, 2000
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