November 11, 1999
Jarl G. Kallberg, Crocker H. Liu, and Anand Srinivasan
ABSTRACT
One of the most controversial topics in modern financial economics is "excess volatility:" the notion that stock prices move too much to be explained by fundamental economic and firm-specific factors. While the initial work of Shiller indicated a high degree of excess volatility, subsequent research indicates that the degree of excess volatility is less than initially supposed and at least partially due to dividend smoothing. This article attempts to determine whether or not dividend smoothing is indeed a major contribution to excess volatility. By focusing on a special class of equities, real estate investment trust (REITs). which are constrained to pay out almost all after-tax profits as dividends, we test for excess volatility using the West and Campbell-Shiller variance bounds methodology. We find that mitigating dividend smoothing behavior leads to rejection of the hypothesis of excess volatility. We conclude that previous findings of excess volatility may be an artifact of dividend smoothing and econometric technique.
Kallberg: (212) 998-0339 jkallber@stern.nyu.edu
Liu: (212) 998-0353 cliu@stern.nyu.edu
Srinivasan: asriniva@stern.nyu.edu
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