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An Empirical Test of the Accounting-Based Residual Income Model and the Traditional Dividend Discount Model

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  • Xiaoquan Jiang

    (University of Northern Iowa)

  • Bon-Soo Lee

    (College of Business, Florida State University)

Abstract

Given the failure of the conventional dividend discount model to explain volatile, dynamic stock price movements, we test the empirical validity of an alternative model, the accounting-based residual income model (RIM), which posits that the current stock price equals the current book value of equity plus the present value of expected future residual income. We test two implications of the two models: volatility of prices relative to fundamentals and the model's dynamic implications by cross-equation restrictions. We find that, for stock valuation, book values and accounting earnings in the RIM contain more useful information than dividends alone.

Suggested Citation

  • Xiaoquan Jiang & Bon-Soo Lee, 2005. "An Empirical Test of the Accounting-Based Residual Income Model and the Traditional Dividend Discount Model," The Journal of Business, University of Chicago Press, vol. 78(4), pages 1465-1504, July.
  • Handle: RePEc:ucp:jnlbus:v:78:y:2005:i:4:p:1465-1504
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    Citations

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    Cited by:

    1. Pan, Ming-Shiun, 2007. "Permanent and transitory components of earnings, dividends, and stock prices," The Quarterly Review of Economics and Finance, Elsevier, vol. 47(4), pages 535-549, September.
    2. Ahmad, Mahyudin, 2012. "Duration dependence test for rational speculative bubble: the strength and weakness," MPRA Paper 42156, University Library of Munich, Germany.
    3. Piergiorgio Alessandri & Donald Robertson & Stephen Wright, 2008. "Miller and Modigliani, Predictive Return Regressions and Cointegration," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 70(2), pages 181-207, April.
    4. Jiang, Xiaoquan & Lee, Bong-Soo, 2007. "Stock returns, dividend yield, and book-to-market ratio," Journal of Banking & Finance, Elsevier, vol. 31(2), pages 455-475, February.
    5. Tswei, Keshin, 2013. "Is transaction price more value relevant compared to accounting information? An investigation of a time-series approach," Pacific-Basin Finance Journal, Elsevier, vol. 21(1), pages 1062-1078.
    6. Kuo, Chen-Yin, 2016. "Does the vector error correction model perform better than others in forecasting stock price? An application of residual income valuation theory," Economic Modelling, Elsevier, vol. 52(PB), pages 772-789.
    7. repec:kap:rqfnac:v:49:y:2017:i:1:d:10.1007_s11156-016-0587-8 is not listed on IDEAS
    8. Man Fu & Prasad V. Bidarkota, 2011. "Periodically Collapsing Bubbles in Stock Prices Cointegrated with Broad Dividends and Macroeconomic Factors," Journal of Risk and Financial Management, MDPI, Open Access Journal, vol. 4(1), pages 1-36, December.
    9. 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.
    10. Schröder, David & Esterer, Florian, 2012. "A new measure of equity duration: The duration-based explanation of the value premium revisited," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 62077, Verein für Socialpolitik / German Economic Association.

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