Inflation Illusion and Stock Prices

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Inflation Illusion and Stock Prices

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Title: Inflation Illusion and Stock Prices
Author: Vuolteenaho, Tuomo; Campbell, John

Note: Order does not necessarily reflect citation order of authors.

Citation: Campbell, John Y., and Tuomo Vuolteenaho. 2004. Inflation illusion and stock prices. American Economic Review 94, no. 2: 19-23.
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Abstract: 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.
Published Version: http://dx.doi.org/10.1257/0002828041301533
Terms of Use: This article is made available under the terms and conditions applicable to Other Posted Material, as set forth at http://nrs.harvard.edu/urn-3:HUL.InstRepos:dash.current.terms-of-use#LAA
Citable link to this page: http://nrs.harvard.edu/urn-3:HUL.InstRepos:3196090
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