Abstract: Recent research indicates that results of variance-bounds
tests of stock price volatility may depend on the definition
of cash flows deemed relevant to shareholders: Tests using
regular (or "narrow") dividends repeatedly have suggested that
stock prices fluctuate more than can be explained by a simple
present value hypothesis, while some tests using "broad
dividends" (i.e., narrow dividends plus proceeds from share
liquidations) do not detect such excess price volatility.
Researchers disagree as to the cause and meaning of these
differences.
This paper derives and analyzes the broad-dividend
version of the present value hypothesis to show that under
common assumptions, these differences in variance-bounds tests
have only two possible causes: Either narrow-dividend tests
have rejected the present value hypothesis because of bubbles
(either rational bubbles, or "empirical" bubbles as might be
effected by dividend-smoothing or dividend-nonpayment); or
broad-dividend tests simply have lacked power to detect
mispricing. Using simulation and results from previous
studies, this paper demonstrates that the second possible
cause -- the lack of power in broad-dividend tests -- most
likely explains the differences between narrow- and
broad-dividend variance-bounds tests.
Keywords: Volatility, variance bounds, stock prices
Full paper (758 KB PDF)
| Full paper (984 KB Postscript)
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