Re: Edward Prescott, Idiot
From: Igor (jjweatherby_at_houston.rr.com)
Date: 10/31/04
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Date: Sun, 31 Oct 2004 19:38:40 GMT
Robert Vienneau wrote:
> In article <krXgd.29451$EI6.22515@fe2.texas.rr.com>, Igor
> <jjweatherby@houston.rr.com> wrote:
>
> "The 1929 Stock Market: Irving Fisher Was Right," Ellen R. McGrattan
> and Edward C.Prescott
> <http://research.mpls.frb.fed.us/research/sr/sr294.pdf>
>
>>Returns are equal to the interest rate * K. You use
>>the interest rate because in competitive markets returns on assets will
>>be equal therefore no one has incentive to switch assets unless
>>conditions change.
>>
>>Now how do you measure capital at market value? The Price of one unit is
>>EQUAL TO ITS MARGINAL COST if the market is competitive.
>
>
> That statement is close to the claim that the interest rate
> is equal to the marginal product of capital. So I think it
> mistaken, too.
>
It is a result for General equilibrium analysis in perfect capital
markets. It is not mistaken. What you mean is that the assumption may
not hold in real markets because they are not perfect. I agree but these
are simplifying assumptions so that you can actually measure something.
>
>>Change in K = Investment(deflated) - (deprecation
>>rate)K(t-1) . That is how you build a stock using the perpetual
>>inventory method.
>
>
> Technically, the above equation is incorrect. The theoretically
> exact way to treat fixed capital is as a kind of joint production.
> Accounting has a lot of convention built into it.
>
We are not talking about theoritically exact ways. We are talking about
what is done in econometric practice. Often therotically exact ways
leave with methods that are untractable or you can not find the complete
data on.
>
>>WHAT IS THE DEFINITION OF UNDERVALUED. The definition says that
>>expectations of future profits ARE BELOW CURRENT PROFITS.
>
>
> Nope. And that is not the definition McGrattan and Prescott use.
>
Completely wrong. All you have to do is look at the abstract to find
this out. I haven't found the link to the full paper again but this is
from the abstract.
" In this paper, we use growth theory to estimate the fundamental value
of corporate equity and compare it to actual stock valuations. "
The measure price compared to actual returns. When actual fundemental
value is high and actual stock market valuations are low then it is
undervalued. In other words when expectations of value are lower than
actual value the stock is undervalued. THIS DOES NOT SAY PRICE WILL
RISE. IT SAYS PEOPLE ARE EXPECTING FUTURE PROFITS TO BE LOWER THAN
CURRENT PROFITS. The result gives credence to the Rational expectations
hypothesis. It says that people forsaw the crash before it happened and
adjust expectations BEFORE the event occured.
You think the finding is absurd because you believe that undervalued
says that the price will be higher in 3 months. No one says this.
Undervalued says that expected profits are much lower than actual
profits. This means that the market believes profits will be lower or
they were surprised the firm did much better. NO stock broker will say
an undervalued stock is a guaranteed winner. They will buy undervalued
stocks if they believe the market expectations are off. If they believe
the market expectations are correct they will not buy an undervalued stock.
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