Stock price booms and expected capital gains

Trabajo presentado en el Economics Emory Seminars, organizado por el Departamento de Económicas del Emory College of Arts & Sciences (Atlanta), celebrado el 2 de marzo de 2017The booms and busts in U.S. stock prices over the post-war period can to a large extent be explained by áuctuations in investorsí subjective capital gains expectations. As we show, survey measures of these expectations display excessive optimism at market peaks and excessive pessimism at market troughs. Using the framework of Internal Rationality of Adam and Marcet (2011), we incorporate subjective price beliefs into an otherwise standard asset pricing model with utility maximizing investors. We show how subjective belief dynamics can temporarily delink stock prices from their fundamental value and give rise to asset price booms that ultimately result in a price bust. The model quantitatively replicates (1) the volatility of stock prices and (2) the positive correlation between the price dividend ratio and expected returns observed in survey data. Models imposing objective or ërationalíprice expectations cannot simultaneously account for both facts. Our Öndings imply that large parts of U.S. stock price áuctuations are not due to standard fundamental forces, instead result from self-reinforcing belief dynamics triggered by these fundamentals.Klaus Adam thanks the Bank of Japan for the hospitality o§ered during early stages of this pro ject. Albert Marcet acknowledges support from Programa de Excelencia del Banco de EspaÒa, Plan Nacional (Ministry of Education), SGR (Generalitat de Catalunya). Klaus Adam and Albert Marcet acknowledge support from the European Research Council under the EU 7th Framework Programme (FP/2007-2013), Starting Grant Agreement No. 284262 (Adam) and Advanced Grant Agreement No. 324048 (Marcet). Klaus Adam and Albert Marcet thank Fondation Banque de France for its support on this pro ject.Peer reviewe