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Some further theoretical and empirical implications regarding the relationship between earnings, dividends and stock prices

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  • Chiang, Raymond
  • Davidson, Ian
  • Okunev, John
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    Abstract

    In this paper earnings, dividends and stock prices are modelled within a plausible economic framework. The first stage in the analysis involves characterisation of the dynamic behaviour of earnings, for which evidence was found for mean reverting behaviour in the long term, and weaker evidence for mean reversion in the short term. The relationship between dividends and earnings is then examined using a modified form of the Lintner model, the empirical results suggesting that the modified formulation performs as effectively as the original Lintner approach. Based upon the assumption that the share price represents the discounted value of future expected dividends, and that dividends are generated by the modified Lintner model, we then go on to develop the functional form of the corresponding share price relationship. As a consequence of using a generalised model for earnings we are able to examine theoretically, through suitable choice of parameter values, the effect of different earnings processes on share price behaviour. The empirical results imply that changes in earnings per share are important in explaining returns.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 21 (1997)
    Issue (Month): 1 (January)
    Pages: 17-35

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    Handle: RePEc:eee:jbfina:v:21:y:1997:i:1:p:17-35

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    1. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-36, June.
    2. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
    3. Chiang, Raymond & Liu, Peter & Okunev, John, 1995. "Modelling mean reversion of asset prices towards their fundamental value," Journal of Banking & Finance, Elsevier, vol. 19(8), pages 1327-1340, November.
    4. James M. Poterba & Lawrence H. Summers, 1987. "Mean Reversion in Stock Prices: Evidence and Implications," NBER Working Papers 2343, National Bureau of Economic Research, Inc.
    5. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October.
    6. Mankiw, N Gregory & Romer, David & Shapiro, Matthew D, 1985. " An Unbiased Reexamination of Stock Market Volatility," Journal of Finance, American Finance Association, vol. 40(3), pages 677-87, July.
    7. John Y. Campbell & Robert J. Shiller, 1988. "Stock Prices, Earnings and Expected Dividends," NBER Working Papers 2511, National Bureau of Economic Research, Inc.
    8. McQueen, Grant & Thorley, Steven, 1991. " Are Stock Returns Predictable? A Test Using Markov Chains," Journal of Finance, American Finance Association, vol. 46(1), pages 239-63, March.
    9. Merton H. Miller & Franco Modigliani, 1961. "Dividend Policy, Growth, and the Valuation of Shares," The Journal of Business, University of Chicago Press, vol. 34, pages 411.
    10. Kim, Myung Jig & Nelson, Charles R & Startz, Richard, 1991. "Mean Reversion in Stock Prices? A Reappraisal of the Empirical Evidence," Review of Economic Studies, Wiley Blackwell, vol. 58(3), pages 515-28, May.
    11. De Bondt, Werner F M & Thaler, Richard, 1985. " Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
    12. Marsh, Terry A & Merton, Robert C, 1987. "Dividend Behavior for the Aggregate Stock Market," The Journal of Business, University of Chicago Press, vol. 60(1), pages 1-40, January.
    13. Summers, Lawrence H, 1986. " Does the Stock Market Rationally Reflect Fundamental Values?," Journal of Finance, American Finance Association, vol. 41(3), pages 591-601, July.
    14. Kormendi, Roger & Lipe, Robert, 1987. "Earnings Innovations, Earnings Persistence, and Stock Returns," The Journal of Business, University of Chicago Press, vol. 60(3), pages 323-45, July.
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    Cited by:
    1. Steven Li, 2002. "A valuation model for firms with stochastic earnings," School of Economics and Finance Discussion Papers and Working Papers Series 122, School of Economics and Finance, Queensland University of Technology.
    2. Chiarella, Carl & Gao, Shenhuai, 2004. "The value of the S&P 500--A macro view of the stock market adjustment process," Global Finance Journal, Elsevier, vol. 15(2), pages 171-196, August.
    3. Gallagher, Liam A & Taylor, Mark P, 2001. "Risky Arbitrage, Limits of Arbitrage, and Nonlinear Adjustment in the Dividend-Price Ratio," Economic Inquiry, Western Economic Association International, vol. 39(4), pages 524-36, October.
    4. Simon Gervais & Ron Kaniel & Dan Mingelgrin, . "The High Volume Return Premium," Rodney L. White Center for Financial Research Working Papers 01-99, Wharton School Rodney L. White Center for Financial Research.
    5. Jirasakuldech, Benjamas & Emekter, Riza & Rao, Ramesh P., 2008. "Do Thai stock prices deviate from fundamental values?," Pacific-Basin Finance Journal, Elsevier, vol. 16(3), pages 298-315, June.
    6. Ian Davidson & Chris Mallin, 1998. "The influence of earnings per share on capital issues: some evidence from UK companies," The European Journal of Finance, Taylor & Francis Journals, vol. 4(3), pages 305-309.
    7. Carl Chiarella & S. Gao, 2002. "Modelling the Value of the S&P 500 - A System Dynamics Perspective," Working Paper Series 115, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
    8. Ramaprasad Bhar, 2010. "Stochastic Filtering With Applications In Finance:," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 7736.
    9. G. Lim, 2005. "Bounded dividends, earnings and fundamental stock values," Empirical Economics, Springer, vol. 30(2), pages 411-426, 09.
    10. Liow, Kim Hiang, 2003. "Property Company Stock Price and Net Asset Value: A Mean Reversion Perspective," The Journal of Real Estate Finance and Economics, Springer, vol. 27(2), pages 235-55, September.
    11. Margaret Bray & Giovanni Marseguerra, 2002. "Divdends and Equity Prices: The Variance Trade Off," FMG Discussion Papers dp413, Financial Markets Group.
    12. Mark Kamstra, 2001. "Rational exuberance: The fundamentals of pricing firms, from blue chip to “dot com”," Working Paper 2001-21, Federal Reserve Bank of Atlanta.
    13. Dennis R. Capozza & Patric H. Hendershott & Charlotte Mack, 2004. "An Anatomy of Price Dynamics in Illiquid Markets: Analysis and Evidence from Local Housing Markets," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 32(1), pages 1-32, 03.
    14. Steven Li, 2003. "A valuation model for firms with stochastic earnings," Applied Mathematical Finance, Taylor & Francis Journals, vol. 10(3), pages 229-243.

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