Dividends And Stock Valuation: A Study From The Nineteenth To The Twenty-First Century (Page 8 of 45) in pdf

Dividends And Stock Valuation: A Study From The Nineteenth To The Twenty-First Century Page 8

evidence that the expected return for an asset changes over time as a result of changes in the market risk

premium and/or changes in the beta or sensitivity of the asset to systematic risk.

We approach this issue from a slightly different perspective. Since the fundamental valuation

techniques require one to discount future expected dividends, we use the actual prices to derive the

implied discount rate used by investors. We therefore study how the implied discount rate has changed

over time and how this compares to what investors would have rationally expected at each point in time.

Studies such as Fama and French (2000), Jagannathan, McGratten and Scherbina (2000), Pastor and

Stambaugh (2000), Welch (2000), Claus and Thomas (2001), and Arnott and Bernstein (2002) use

various techniques to estimate the expected equity premium and suggest the equity premium has changed

over time and it is unlikely that one could have used information available at the beginning of the

twentieth century to predict how large it turned out to be throughout the latter part of the century.

Consistent with this, Welch (2000) provides interesting evidence suggesting that many financial

economists currently believe the equity premium to be even larger than empirical evidence suggests it is.

This discrepancy between what investors would rationally have believed the equity premium would be

and the actual premium could have a significant impact on valuation (for an interesting discussion see

Arnott and Bernstein (2002)).

Building on the research areas discussed above, our study helps to address a couple of important

gaps in the literature. First, we perform a detailed investigation of changes in how investors value

dividends and the impact of these changes on prices over time. Using fundamental valuation methods we

are able to study how changes in dividends impact the expected prices and compare these to the observed

prices. By understanding how these relationships change over time, we provide insight into some of the

potential sources of concern for the performance of different asset pricing models. Second we consider

how changes in the cost of equity (one of the most important inputs in our fundamental valuation models

and in empirical asset pricing models) impact the valuation of assets over time. Understanding how the

cost of equity changes over time and across market conditions may provide us with insight into the

directions future work in asset pricing should consider.

Dividends And Stock Valuation: A Study From The Nineteenth To The Twenty-First Century Page 8