Stock Prices and Fundamentals in a Production Economy

This paper by the Federal Reserve Board compares the predictions for the market value of firms from the Gordon growth model with those from a dynamic general equilibrium model of production. Special attention is focused on the prediction for movements in the market value of firms in response to a decline in the required return or an increase in the growth rate of the economy. The tension between theory and data suggests that the skyrocketing market value of firms in the second half of the 1990s may reflect a degree of irrational exuberance.