Dividend growth, stock valuation, and long-run risk

Abstract

In this paper, we integrate the long-run concept of risk into the stock valuation process. We use the intertemporal consumption capital asset pricing model to demonstrate that a stock's long-run dividend growth is negatively related to its current dividend-price ratio and positively related to its long-run covariance between dividends and consumption. Then, we show that the equilibrium price of a stock is determined by its current dividend, long-run dividend growth, and longrun risk. In all, our work suggests that risk cumulated over many periods represents an important parameter in assessing the theoretical value of a firm.

Dividend sensitivity to economic factors, stock valuation, and long-run risk

“…In this sense, it is very similar to what Bansal et al (2002, p. 5) call dividend beta or what Abel (1999) identifies as the key determinant of the risk premia (see also Bergeron, 2011). Another special case of our model can also be proposed if we accept, as in Bansal et al (2005), that the relationship between dividend and consumption growth rates is given by the following linear functioñ…”

“…Following Bergeron (2011) and others before, 6 our intertemporal equilibrium framework considers a closed economy populated by identical agents. At time t, each agent maximizes the time-separable utility function 7…”

“…More recently, Bergeron (2011) develops a valuation model that integrates the long-run definition of consumption risk into the stock valuation process.…”

“…In this paper, we extend the work of Bergeron (2011) in integrating the multidimensionality of uncertainty, as well as the long-run concept of risk, into the stock valuation process.…”

“…Compared to Bergeron (2011), our methodology presents two major differences, in addition to the integration of the multidimensionality of uncertainty. First, the constant relative risk aversion assumption via the power utility function is not required.…”