Stock Price Booms and Expected Capital Gains

Recognition Program

Authors: Klaus Adam, Albert Marcet and Johannes Beutel

American Economic Review, Vol. 107, No 8, 2352-2408, September, 2017

Investors’ subjective capital gains expectations are a key element explaining stock price fluctuations. Survey measures of these expectations display excessive optimism (pessimism) at market peaks (troughs). We formally reject the hypothesis that this is compatible with rational expectations. We incorporate subjective price beliefs with such properties into a standard asset-pricing model with rational agents (internal rationality). The model gives rise to boom-bust cycles that temporarily delink stock prices from fundamentals. It quantitatively replicates many asset-pricing moments, including the observed strong positive correlation between the price dividend ratio and survey return expectations, which cannot be matched by rational expectations.

This paper originally appeared as Barcelona School of Economics Working Paper 757
This paper is acknowledged by the Barcelona School of Economics Recognition Program