Why Does the Stock Market Fluctuate?
NBER Working Paper No. 3995
Large long-run swings in the United States stock market over the past century correspond to swings in estimates of fundamental values calculated by using a long moving average of past dividend growth to forecast future growth rates. Such a procedure would have been reasonable if investors were uncertain of the structure of the economy. and had to make forecasts of unknown and possibly-changing long-run dividend growth rates. The parameters of the stochastic process followed by dividends over the twentieth century cannot be precisely estimated even today at the century's end. Investors in the past had even less information about the dividend process. In such a context, it is difficult to see how investors can be faulted for implicitly forecasting future dividends by extrapolating past dividend growth.
Published: Quarterly Journal of Economics, Vol. 108, no. 2 (1993): 291-311.