This paper examines the extent to which swings in stock prices can be related to variations in the discounted value of expected future dividends when investors face uncertainty about their future behaviour. First, I present evidence of instability in time series behaviour of dividends and discount rates over the past 120 years and show that it can be well represented by switching processes. I then develop a model for the log dividend-price ratio in which investors rationally anticipate the future switches in the dividend and discount rate processes. Estimate of the model reveal that changing forecasts of future dividend growth account for more than 90% of the predictable variations in dividend-prices. the estimates also imply that process switches contribute significantly to the apparent "excess volatility" of dividend-prices and the predictability of stock returns.
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