Switching Equilibria: The Present Value Model for Stock Prices Revisited

Jesús Vázquez, Universidad del País Vasco

Abstract

This paper analyzes the dynamic features displayed by alternative rational expectatioms equilibria in the context of the present value for stock prices with feedback. In particular, it shows that there exists a unique equilibrium implying cointegration and that equilibrium is characterized by either the fundamental or, alternatively, the backward solution depending on the size of the feedback parameter. It is shown analytically that the existence of switching equilibria induces large stock market swings. Using US data and structural estimation, the hypotheses of feedback and switching equilibria are tested. The empirical results provide evidence of both switching equilibria and feedback.