(An) empirical implication of the dividend discount model

Abstract

A simple model asserts that real stock price equals the present value of rationally expected or optimally forecasted future real dividends discounted at a constant real discount rate. It has often been claimed in popular discussions that stock price seems too volatile compared to what is implied by the dividend discount model. Multiperiod equilibrium models are employed to determine the firm value. Then the stock price per share can be directly computed from the firm value and the number of shares. Given the aggregate payout, firms can choose many different dividend policies. According to each dividend policy, the stock price per share and the dividend per share would be fluctuated differently. We simulate our model by generating the aggregate payout under the different assumptions of stochastic process and investors`` utility functions. Like Shiller, we compare the variance of real stock index with that of the discounted value of actual subsequent dividends by assuming a dividend policy and the stochastic process of aggregate payout of firms. We conclude that Var$(P(t)^\star) << Var(P(t))$ can be possible even if the dividend discount model is correct.