Present Value Of Future Dividends Research Articles

Stable dividends under linear-quadratic optimisation

The optimisation criterion for dividends from a risky business is most often formalised in terms of the expected present value of future dividends. That criterion disregards a potential, explicit demand for the stability of dividends. In particular, within actuarial risk theory, the maximisation of future dividends has been studied as the so-called de Finetti problem. However, there the optimal strategies typically become so-called barrier strategies. These are far from stable, and suboptimal affine dividend strategies have recently received attention. In contrast, in the class of linear-quadratic problems, the demand for stability is explicitly stressed. These have often been studied in diffusion models different from the actuarial risk models. We bridge the gap between these thinking patterns by deriving optimal affine dividend strategies under a linear-quadratic criterion for an additive process. We characterise the value function by the Hamilton-Jacobi-Bellman equation, solve it, and compare the objective and the optimal controls to the classical objective of maximising the expected present value of future dividends. Thereby we provide a framework within which stability of dividends from a risky business, e.g. in classical risk theory, is explicitly demanded and obtained.

The Impact of Federal Reserve's Conventional and Unconventional Monetary Policies on Equity Prices

I estimate the effects of the Federal Reserve's forward guidance and large-scale asset purchases, along with the effects of interest rate changes under conventional policy, on the U.S. equity market, and assess the reasons for stock price responses. Although the overall stock market respond meaningfully to a surprise change in the federal funds rate with a high level of statistical significance, a heterogeneity in responses is observed among different sectors in the stock market. In contrast, forward guidance is found to have relatively homogeneous effects on sector-wise stock market performance. Such effects are large in magnitude and highly statistically significant. However, large-scale asset purchases exhibit minimal effects on equity price movements. The present value of future excess returns emerged as the most important channel through which the surprise changes in the federal funds rate as well as forward guidance and large-scale asset purchases affect current equity prices. The present value of future dividends and the real interest rates are found to make minor contributions the propagation of policy shocks. However, the relative contribution of future dividends, real interest rates and excess returns vary across sectors.

Using Behavioral Economics to Analyze Credit Policies in the Banking Industry

1. Introduction Are private banks efficient when providing credit to the real economy? Probably, in the last decades there has not been such a bitter debate in academic research as the one related to efficiency in financial markets. Hence, we will not find a unanimous answer to that question, but in the midst of the worst financial crisis since the Great Depression, it seems unavoidable to wonder how did all go wrong? Kindleberger (1978) provided what Shleifer (2000) named the 'anatomy of a price bubble': a process that starts with some good news that generate a profit in an asset, followed by a 'smart-money response' where both the supply and the demand of such asset are encouraged by initial investors. The bubble is then sustained by the same investors, who stimulate positive feedback trading by (...) facilitating noise trader speculation (Shleifer, 2000, p.172). That is, the same agents who are benefited in the early stages of the bubble generate a greater supply of the asset and encourage other actors to participate, increasing the demand and sustaining asset prices until the market, eventually, collapses. Hens and Bachmann (2008) explain the anatomy of the financial bubble that led to our present crisis. They interpret the initial good news that rose prices on the real estate market as the speculative money coming into the house market after the dot-com bubble burst. Then, smart-money investors started the packaging of mortgage risks in new securities (MBS) that are sold outsourced in special investment vehicles (SIV) and sold worldwide (p.94). This approach is focused on the role that subprime mortgages had in the process that led to the crisis, but in this paper we want to delve a little deeper into the study of how the 'smart-money response' promoted the credit growth in order to sustain the bubble. The financial meltdown highlighted significant shortcomings on procedures used by the banking sector when providing credit to the real economy for two reasons. First, a long period of indulgence granting personal loans and mortgages boosted the credit bubble all over the world, and second, after the collapse of Lehman Brothers, an era of suspicion within the banking sector precipitated the liquidity crunch and the credit squeeze to private agents. A traditional approach to analyze market efficiency is the efficient market hypothesis (EMH) by Fama (1970) applied to capital markets. In this paper we will first provide a brief outlook on several ideas that behavioral economics has presented when analyzing the EMH in the context of capital markets, and then, in the bulk of this paper, we shall apply that analysis to the study of retail banking sector -both from a macro and a micro perspective- when granting credit to businesses and households. 2. Behavioral Finance and the EMH on Capital Markets The efficient market hypothesis (EMH) postulates market prices reflect the 'true value' of capital stock, given information available. Fama (1970) sees three categories in the EMH. Under the weak-form EMH, current stock prices fully reflect all currently available market information. Hence, past price and volume information would have no relationship with the future direction of security prices. The semistrong-form EMH assumes current stock prices adjust rapidly to the release of any market and non-market information available to the agents. Finally, the strong-form EMH version implies that prices fully reflect all public and private information. The strong-form assumes perfect markets where information is cost-free and available to all market participants at the same time. (3) Empirical data has challenged the EMH. Relevant examples are Shiller (1981), De Bondt and Thaler (1985), Jegadeesh and Titman (1993), Siegel (1998) or even Fama (1991) and Fama and French (1992), which evidence market anomalies inconsistent with market rationality. Empirical evidence against the weak form EMH include stock market volatility much higher than justified by the expected net present value of future dividends, extreme losers (the worst performing stocks over a long period in the past) outperforming extreme winners in the short future -a sign of overreaction and return to the mean- or, on the contrary, for short term periods price movements over six to twelve months tend to predict future movements in the same direction (which is called 'momentum'). …

Optimal Mixed Impulse-Equity Insurance Control Problem With Reinsurance

We investigate an optimal financing and dividend control problem of an insurance company facing fixed and proportional transaction costs. The goal of the company is to maximize the expected present value of future dividends after deduction of the equity issuance until the time of bankruptcy. We formulate the problem as a mixed classical-impulse control and discuss the problem using the HJB dynamic programming approach. A viscosity solution is considered and its uniqueness is established. We also give results for the regularity and structure of the value function and the optimal policy of the control problem.

Estimation of Cost of Capital and its Reliability

Gordon and Shapiro (1956) first equated the price of a share with the present value of future dividends and derived the well-known relationship. Since then, there are many improvement on the theory, for example, Thompson (1985, 1987) combined the yield plus growth' method with Box-Jenkins time series analysis of past dividend experience to estimate the cost of capital and its credibility for individual firms while Thompson and Wong (1991, 1996) further extended the study of statistical time series methodology for estimating the cost of equity capital by proving the existence and uniqueness of the cost of capital and estimating its reliability. However, their approaches could not be used if the reliability does not exist or if there are multiple solution for the reliability. Wong and Chan (2004) extended the theory by proving the existence and uniqueness of the reliability. They further studied the properties of the cost of capital and simplify the estimation procedure. This paper discusses their contribution and the applications of the theory.

Bank Holding Company Dividend Policy: Changed by Recession?

This study examines seven basic theories of dividend policies in bank holding companies during the worst recession since The Great Depression. Data is obtained from Uniform Bank Performance Reports for 2008 where large losses were reported for the US banks. Previous studies found that the management of the companies believe that dividend policy is important created by the present value of future dividends, or the capital gains associated with the future dividends. Dickens et al used Barclay et al model and studied the factors that may have an impact on dividend policies of publicly traded bank holding companies. Their results indicate investment opportunity, size, expected earnings, inside ownership and previous dividend are significant factors in bank holding companies dividend policies. The model used in this paper includes investment opportunities, regulation, agency affects, dividend smoothing, earnings risk, and residual earnings and found that there is a difference between dividend policies of bank holding companies during deep recession and good economy. Furthermore, factors such as investment opportunity, dividend history, size, residual earnings and insider ownership have significant affect on dividend policies of bank holding companies.

Can political factors explain the behaviour of stock prices beyond the standard present value models?

This article documents that political factors can be linked to that part of stock prices which cannot be explained by the standard present value models. The nonfundamental component of stock market index appears to be significantly influenced by the political orientation of the president and his approval rating, election cycle and military conflicts. The findings presented here indicate that there is much more to the price formation process than the present value of future dividends.

Efficient option pricing on stocks paying discrete or path-dependent dividends with the stair tree

Pricing options on a stock that pays discrete dividends has not been satisfactorily settled because of the conflicting demands of computational tractability and realistic modelling of the stock price process. Many papers assume that the stock price minus the present value of future dividends or the stock price plus the forward value of future dividends follows a lognormal diffusion process; however, these assumptions might produce unreasonable prices for some exotic options and American options. It is more realistic to assume that the stock price decreases by the amount of the dividend payout at the ex-dividend date and follows a lognormal diffusion process between adjacent ex-dividend dates, but analytical pricing formulas and efficient numerical methods are hard to develop. This paper introduces a new tree, the stair tree, that faithfully implements the aforementioned dividend model without approximations. The stair tree uses extra nodes only when it needs to simulate the price jumps due to dividend payouts and return to a more economical, simple structure at all other times. Thus it is simple to construct, easy to understand, and efficient. Numerous numerical calculations confirm the stair tree's superior performance to existing methods in terms of accuracy, speed, and/or generality. Besides, the stair tree can be extended to more general cases when future dividends are completely determined by past stock prices and dividends, making the stair tree able to model sophisticated dividend processes.

An equilibrium model of insider trading in continuous time

We study a Bayesian–Nash equilibrium model of insider trading in continuous time. The supply of the risky asset is assumed to be stochastic. This supply can be interpreted as noise from nonrational traders (noise traders). A rational informed investor (the insider) has private information on the growth rate of the dividend flow rewarded by the risky asset. She is risk averse and maximizes her inter-temporal utility rate over an infinite time-horizon. The market is cleared by a risk neutral market maker who sets the price of the risky asset competitively as the conditional present value of future dividends, given the information supplied by the dividend history and the cumulative order flow. Due to the presence of noise traders, the market demand does not fully reveal the insider’s private information, which slowly becomes incorporated in prices. An interesting result of the paper is that a nonstandard linear filtering procedure gives an a priori form for the equilibrium strategy to be postulated. We show the existence of a stationary linear equilibrium where the insider acts strategically by taking advantage of the camouflage provided by the noise which affects the market maker’s estimates on private information. In this equilibrium, we find that the insider’s returns on the stock are uncorrelated over long periods of time. Finally, we show that the instantaneous variance of the price under asymmetric information lies between the instantaneous variance of the price under complete and incomplete information. The converse inequalities hold true for the unconditional variance of the price.

Extension of 'Dividend Policy, Growth, and the Valuation of Shares' by Miller and Modigliani (1961) to Allow for Share Repurchases

Miller and Modigliani (1961) consider valuation of infinite horizon firms that may not engage in purchasing their own shares. While their fundamental valuation approach also applies to firms that purchase their own shares, their stream of dividends approach does not apply to such firms if they pay out “insufficient” dividends, as characterized by a necessary and sufficient condition in this paper. The latter approach is modified so that it can be used for valuation of infinite horizon firms including those that purchase their own shares. The modified approach is the natural extension of the traditional dividend stream approach used for valuing finite horizon firms, and it is proved to be equivalent to the fundamental valuation approach. Our analysis suggests that if share prices are estimated based solely on their dividend contents, then it would be important to test empirically if the share price of a firm paying insufficient dividends will be undervalued.For related papers, see Sethi, When Does the Share Price Equal the Present Value of Future Dividends? A Modified Dividend Approach, Economic Theory, Vol. 8, No. 2, pp. 307-319, 1996 (http://ssrn.com/abstract=1083168) and Sethi, Derzko and Lehoczky, A Stochastic Extension of the Miller-Modigliani Framework, Mathematical Finance, Vol. 1, Issue 4, pp. 57-76, October 1991;(http://ssrn.com/abstract=1082940) both available on SSRN.

Can Political Factors Explain the Behavior of Stock Prices Beyond the Standard Present Value Models?

This paper documents that political factors can be linked to the part of stock prices that cannot be explained by the standard present value models. The non-fundamental component of stock market index appears to be significantly influenced by the political orientation of the president and his approval rating, election cycle and military conflicts. The findings presented here indicate that there is much more to the price formation process than the present value of future dividends.

On the estimation of cost of capital and its reliability

Gordon and Shapiro (1956 Management Sci. 10 102–10) first equated the price of a share with the present value of future dividends and derived the well known relationship. Since then, there have been many improvements on the theory. For example, Thompson (1985 Managerial Decis. Economics 6 132–40, 1987 Managerial Decis. Economics 8 321–32) combined the ‘dividend yield plus growth’ method with Box–Jenkins time series analysis of past dividend experience to estimate the cost of capital and its ‘reliability’ for individual firms. Thompson and Wong (1991 Managerial Decis. Economics 12 27–42, 1996 Eng. Economist 41 123–47) proved the existence and uniqueness of the cost of capital and provided a formula to estimate both the cost of capital and its reliability. However, their approaches cannot be used if the ‘reliability’ does not exist or if there are multiple solutions for the ‘reliability’. In this paper, we extend their theory by proving the existence and uniqueness of this reliability. In addition, we propose estimators for the reliability and prove that the estimators converge to a true parameter. The estimation approach is further simplified, hence rendering computation easier. In addition, the properties of the cost of capital and its reliability will be analysed with illustrations of several commonly used Box–Jenkins models.

Market share instability and stock price volatility during the industry life-cycle: the US automobile industry

Market share instability, during certain stages of the industry life-cycle, has become a stylized fact in the industrial organization literature. In the finance literature, volatility in the form of excess volatility, i.e. the much larger volatility of stock prices than dividends (although stock prices should in theory trace the present value of future dividends), has given rise to controversies regarding stock price determination (Campbell and Shiller, 1988; Shiller, 1989). Recent evolutionary models, both theoretical and empirical, have tied the presence of market share instability to industry specific variables, such as specific periods in the industry life-cycle and specific “technological regimes”. The object of the paper is to explore whether there is a relationship between market share instability and stock price volatility and to what degree this relationship is connected to the concept of the industry life-cycle, and hence to industry specific factors. To do so, we explore the relationship in one particular industry, the US automobile industry. Since neither life-cycle nor finance theories attack this problem directly, we use insights from both approaches to build hypotheses which guide the data analysis. The empirical results confirm many of these hypotheses, suggesting that the degree of excess volatility is indeed partly affected by industry specific factors.

When does the share price equal the present value of future dividends?

This paper discusses an explicit necessary and sufficient condition on the dividend stream of a publicly traded company, under which the price of the company's share is equal to the present value of the future dividends that will accrue to it. When it is not, the share price equals the present value of the future per share dividend plus the limiting per share value of the company at infinity. It uses a well-accepted generalization of the Miller-Modigliani framework, and assumes that the firm is an infinite horizon firm which may engage in repurchasing its own shares. It develops a proper dividend approach that can value such a firm for any dividend stream. The paper concludes by clarifying some remarks in the Miller-Modigliani paper.

P/E, P/B and the Present Value of Future Dividends

(1994). P/E, P/B and the Present Value of Future Dividends. Financial Analysts Journal: Vol. 50, No. 4, pp. 23-31.

Stock Prices, Earnings, and Expected Dividends

ABSTRACTLong historical averages of real earnings help forecast present values of future real dividends. With aggregate U.S. stock market data (1871–1986), a vector‐autoregressive forecast of the present value of future dividends is, for each year, roughly a weighted average of moving‐average earnings and current real price, with between two thirds and three fourths of the weight on the earnings measure. We develop the implications of this for the present‐value model of stock prices and for recent results that long‐horizon stock returns are highly forecastable.

Risk and the Valuation of Common Stock

It is quite reasonable, and quite acceptable among both academic researchers (Gordon and Shapiro, 1956; Walter, 1956; Modigliani and Miller, 1961; Malkiel, 1963) and professional security analysts (Molodovsky, 1959, 1960, 1965; Bauman, 1965; Wendt, 1965), to view the price of a share of stock as the present value of future dividends expected from the share discounted at a rate which reflects the risk borne by an owner of the share. If the period between dividends is constant, earnings growth is expected to return to normal after some periods at a non-normal rate and dividend payout rate is expected to be the same in evey period; then the price on the date of a dividend payment is described by :1