Date of Award

Summer 1999

Document Type


Degree Name

Doctor of Business Administration (DBA)


I derive testable implications of fundamental and non-fundamental components of stock prices. In order to control for the role of time-varying expected inflation and to be able to perform reasonable empirical tests, I use a nominal (rather than a real) interpretation of the present-value model (PVM), whereby nominal interest rates approximate expected inflation. I conjecture that the fundamental and non-fundamental components represent the permanent and temporary components of stock prices, respectively. A series of cointegration analysis over the annual period 1871–1997 confirms my conjecture for the model with time-varying expected inflation. Various fundamental and non-fundamental exclusion tests indicate that both excess returns and expected inflation are price fundamentals. When both of these factors are present in the fundamental component, the non-fundamental component of stock prices exhibits little deviation from zero. However, the evidence in support of the inflation-augmented PVM seems somewhat sensitive to certain model specifications (notably, lag structures). The Hansen-Johansen recursive analysis reveals that the parameters in the non-fundamental component lack stability in the post-World War II period. Results from subsample analysis verify my suspicion of a significant regime shift. In particular, the inflation augmented-PVM holds only for the pre-WW II period. This implication of excess price volatility, as represented by the augmented PVM, stands up to alternative specifications such as measurements of variables and data frequency. Such evidence is clearly in line with Shiller's (1981) belief in market irrationality and also consistent with Campbell's (1991) conclusion that evidence of market predictability is “overwhelming” only during the post-1950s.