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Some Further Theoretical and Empirical Implications Regarding the Relationship between Earnings, Dividends and Stock Prices

Author

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  • Raymond Chiang
  • Ian Davidson
  • John Okunev

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.

Suggested Citation

  • Raymond Chiang & Ian Davidson & John Okunev, 1996. "Some Further Theoretical and Empirical Implications Regarding the Relationship between Earnings, Dividends and Stock Prices," Working Paper Series 60, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
    • Handle: RePEc:uts:wpaper:60
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    File URL: http://www.finance.uts.edu.au/research/wpapers/wp60.pdf
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    Cited by:

    1. Margaret Bray & Giovanni Marseguerra, 2002. "Divdends and Equity Prices: The Variance Trade Off," FMG Discussion Papers dp413, Financial Markets Group.
    2. Knapp, Morris & Gart, Alan & Chaudhry, Mukesh, 2006. "The impact of mean reversion of bank profitability on post-merger performance in the banking industry," Journal of Banking & Finance, Elsevier, vol. 30(12), pages 3503-3517, December.
    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 524-536, October.
    4. 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, March.
    5. 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.
    6. Mark Kamstra, 2001. "Rational exuberance: The fundamentals of pricing firms, from blue chip to “dot com”," FRB Atlanta Working Paper 2001-21, Federal Reserve Bank of Atlanta.
    7. 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 235-255, September.
    8. Simon Gervais & Ron Kaniel & Dan H. Mingelgrin, 2001. "The High‐Volume Return Premium," Journal of Finance, American Finance Association, vol. 56(3), pages 877-919, June.
    9. Allan Hodgson & John Okunev, 2022. "Long term equity risk premiums in the UK and US: A cautionary tale of weak mean reversion," The European Journal of Finance, Taylor & Francis Journals, vol. 28(17), pages 1728-1744, November.
    10. Jiang, Hao & Ma, Yong & Wang, Tianyang, 2025. "Too many irons in the fire: The impact of limited institutional attention on market microstructure and efficiency," Journal of Financial Markets, Elsevier, vol. 73(C).
    11. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    12. Carl Chiarella & Shenhuai 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.
    13. Dennis R. Capozza & Patric H. Hendershott & Charlotte Mack & Christopher J. Mayer, 2002. "Determinants of Real House Price Dynamics," NBER Working Papers 9262, National Bureau of Economic Research, Inc.
    14. Ramaprasad Bhar, 2010. "Stochastic Filtering with Applications in Finance," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 7736, March.
    15. 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.
    16. Mark Kamstra, 2003. "Pricing firms on the basis of fundamentals," Economic Review, Federal Reserve Bank of Atlanta, vol. 88(Q1), pages 49-70.
    17. Steven Li, 2003. "A valuation model for firms with stochastic earnings," Applied Mathematical Finance, Taylor & Francis Journals, vol. 10(3), pages 229-243.
    18. 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.
    19. 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.
    20. Keith Anderson & Tomasz Zastawniak, 2017. "Glamour, value and anchoring on the changing /," The European Journal of Finance, Taylor & Francis Journals, vol. 23(5), pages 375-406, April.
    21. G. Lim, 2005. "Bounded dividends, earnings and fundamental stock values," Empirical Economics, Springer, vol. 30(2), pages 411-426, September.

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