Department of Economics and Business Economics

The Log-Linear Return Approximation, Bubbles, and Predictability

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The Log-Linear Return Approximation, Bubbles, and Predictability. / Engsted, Tom; Pedersen, Thomas Quistgaard; Tanggaard, Carsten.

In: Journal of Financial and Quantitative Analysis, Vol. 47, No. 3, 2012, p. 643-665.

Research output: Contribution to journal/Conference contribution in journal/Contribution to newspaperJournal articleResearchpeer-review

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Engsted, Tom ; Pedersen, Thomas Quistgaard ; Tanggaard, Carsten. / The Log-Linear Return Approximation, Bubbles, and Predictability. In: Journal of Financial and Quantitative Analysis. 2012 ; Vol. 47, No. 3. pp. 643-665.

Bibtex

@article{ec8cf075eac54627b1082750aa965139,
title = "The Log-Linear Return Approximation, Bubbles, and Predictability",
abstract = "We study in detail the log-linear return approximation introduced by Campbelland Shiller (1988a). First, we derive an upper bound for the mean approximationerror, given stationarity of the log dividend-price ratio. Next, we simulate variousrational bubbles which have explosive conditional expectation, and we investigatethe magnitude of the approximation error in those cases. We …nd that surprisinglythe Campbell-Shiller approximation is very accurate even in the presence of largeexplosive bubbles. Only in very large samples do we …nd evidence that bubblesgenerate large approximation errors. Finally, we show that a bubble model in whichexpected returns are constant can explain the predictability of stock returns fromthe dividend-price ratio that many previous studies have documented.",
keywords = "Stock return, Taylor expansion, bubble, simulation, predictability, re-purchases",
author = "Tom Engsted and Pedersen, {Thomas Quistgaard} and Carsten Tanggaard",
year = "2012",
doi = "10.1017/S0022109012000191",
language = "English",
volume = "47",
pages = "643--665",
journal = "Journal of Financial and Quantitative Analysis",
issn = "0022-1090",
publisher = "Cambridge University Press",
number = "3",

}

RIS

TY - JOUR

T1 - The Log-Linear Return Approximation, Bubbles, and Predictability

AU - Engsted, Tom

AU - Pedersen, Thomas Quistgaard

AU - Tanggaard, Carsten

PY - 2012

Y1 - 2012

N2 - We study in detail the log-linear return approximation introduced by Campbelland Shiller (1988a). First, we derive an upper bound for the mean approximationerror, given stationarity of the log dividend-price ratio. Next, we simulate variousrational bubbles which have explosive conditional expectation, and we investigatethe magnitude of the approximation error in those cases. We …nd that surprisinglythe Campbell-Shiller approximation is very accurate even in the presence of largeexplosive bubbles. Only in very large samples do we …nd evidence that bubblesgenerate large approximation errors. Finally, we show that a bubble model in whichexpected returns are constant can explain the predictability of stock returns fromthe dividend-price ratio that many previous studies have documented.

AB - We study in detail the log-linear return approximation introduced by Campbelland Shiller (1988a). First, we derive an upper bound for the mean approximationerror, given stationarity of the log dividend-price ratio. Next, we simulate variousrational bubbles which have explosive conditional expectation, and we investigatethe magnitude of the approximation error in those cases. We …nd that surprisinglythe Campbell-Shiller approximation is very accurate even in the presence of largeexplosive bubbles. Only in very large samples do we …nd evidence that bubblesgenerate large approximation errors. Finally, we show that a bubble model in whichexpected returns are constant can explain the predictability of stock returns fromthe dividend-price ratio that many previous studies have documented.

KW - Stock return

KW - Taylor expansion

KW - bubble

KW - simulation

KW - predictability

KW - re-purchases

U2 - 10.1017/S0022109012000191

DO - 10.1017/S0022109012000191

M3 - Journal article

VL - 47

SP - 643

EP - 665

JO - Journal of Financial and Quantitative Analysis

JF - Journal of Financial and Quantitative Analysis

SN - 0022-1090

IS - 3

ER -