ABSTRACT
The present value model states that the present value of an asset is derived from its earning power, or the ability to generate future income. This crucially depends on the expectations about future income and the discount rate at which people or investors would sacrifice a portion of their current income for future consumption, after adjusting for uncertainty or risk involved in the process. Although the present value of an asset, or economic value as against accounting value, is the best to reflect its true value, it involves expectations on future income, the discount rate and rationality of people. Therefore, the present value model is difficult to apply properly in practice. Linking the present value of an asset to its future income in the framework of cointegration analysis, as proposed by Campbell and Shiller (1987), has provided a useful tool for testing expectations and rationality in financial markets.
