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| One empirical argument that has been around for some time and that clearly contra- dicts equity market efficiency is that market prices seem too volatile to be optimal estimates of the present value of future discounted cash flows. Based on this it is deduced that systematic pricing errors occur in equity markets which hence can not be efficient in the Effcient Market Hypothesis sense. The paper tries to show that this so-called excess volatility is to a large extend the result of the underlying assumptions which are being employed to estimate the present value of cash flows. Using monthly data for three investment style indices from an integrated European Equity market all usual assumptions are dropped. This is achieved by employing the Gordon Growth Model and using an estimation process for the dividend growth rate that was suggested by Barsky and De Long. In extension to Barsky and De Long the discount rate is not assumed at some arbitrary level but it is estimated from the data. In this manner the empirical results do not rely on the prerequisites of sta- tionary dividends constant dividend growth rates as well as non-variable discount rates. It is shown that indeed volatility declines considerably but is not eliminated. Furthermore it can be seen that the resulting discount factors for the three in- vestment style indices can not be considered equal which on a risk-adjusted basis indicates performance differences in the investment strategies and hence stands in contradiction to an efficient market. Finally the estimated discount rates under- went a plausibility check by comparing their general movement to a market based interest rate. Besides the most recent data the estimated discount rates match the movements of market interest rates fairly well. -- equity market efficiency ; discounted cashflow ; excess volatility ; variance bound test ; rational expectations |
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