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Hard times

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We show that the stock market downturns of 2000-2002 and 2007-2009 have very different proximate causes. The early 2000’s saw a large increase in the discount rates applied to profits by rational investors, while the late 2000’s saw a decrease in rational expectations of future profits. We reach these conclusions using a VAR model of aggregate stock returns and valuations, estimated both freely and imposing the cross-sectional restrictions of the ICAPM. Our findings imply that the 2007-2009 downturn was particularly serious for rational long-term investors, whose losses were not offset by improving stock return forecasts as in the previous recession.

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en

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http://eprints.lse.ac.uk/43097/

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