NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Inflation Illusion and Stock Prices

John Y. Campbell, Tuomo Vuolteenaho

NBER Working Paper No. 10263
Issued in February 2004
NBER Program(s):   EFG   ME   AP

We empirically decompose the S&P 500's dividend yield into (1) a rational forecast of long-run real dividend growth, (2) the subjectively expected risk premium, and (3) residual mispricing attributed to the market's forecast of dividend growth deviating from the rational forecast. Modigliani and Cohn's (1979) hypothesis and the persistent use of the Fed model' by Wall Street suggest that the stock market incorrectly extrapolates past nominal growth rates without taking into account the impact of time-varying inflation. Consistent with the Modigliani-Cohn hypothesis, we find that the level of inflation explains almost 80% of the time-series variation in stock-market mispricing.

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Document Object Identifier (DOI): 10.3386/w10263

Published: Campbell, John Y. and Tuomo Vuolteenaho. "Inflation Illusion And Stock Prices," American Economic Review, 2004, v94(2,May), 19-23. citation courtesy of

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