Dividends And Stock Valuation: A Study From The Nineteenth To The Twenty-First Century (Page 15 of 45) in pdf

Dividends And Stock Valuation: A Study From The Nineteenth To The Twenty-First Century Page 15

than they had before so we might expect this variable to be negatively related to both UP1 and UP2 (i.e.,

actual price might be “too low” thus increasing the UPIs).

Finally, D_CPI is measured as the log change in the year-over-year level of the CPI for the US.

This measure allows our model to capture potential changes in how investors value assets as the level of

inflation changes.

In periods of high inflation, we assume that investors require dividends to be

increasing at a higher rate than in the past – a higher growth rate in dividends is required to offset the loss

of value from inflation. As a result we would expect the actual price to decrease more than the expected

price as inflation is increasing. Increasing inflation should also result in an increase in the cost of equity

and the dividend growth rates.

As with the pricing errors, we also investigate how these economic factors are able to capture the

differences between the expected/estimated cost of equity and the implied cost of equity (URI).

Specifically, for the differences between the estimated and implied cost of equity:

= a + ) b

URI

+ e

(10)

Previous studies which have calculated implied equity premiums (e.g. Jagannathan, McGratten and

Scherbina (2000), Pastor and Stambaugh (2000)) suggest a possible role for macroeconomic factors and

other economic factors in the apparent deviations between the implied cost of equity and the estimated

cost of equity. Specifically, we expect that the implied cost of equity will be greater than the historically

calculated cost of equity when our economic factors suggest a future upswing in economic performance.

The forward looking implied cost of equity will capture the investors’ perception that future conditions

are improving and thus equity prices should be improving in the future.

Since it is possible that the differences between our estimated and implied costs of equity are the

result of changes in one or the other of these measures, we also study the impact of our economic factors

on each measure separately. This means we estimate models for our costs of equity and growth rates

individually:

= a + ) b

+ e

(11)

Dividends And Stock Valuation: A Study From The Nineteenth To The Twenty-First Century Page 15