Skip to main content
Article thumbnail
Location of Repository

Dividends and equity prices: the variance trade off

By Margaret Bray and G. Marseguerra

Abstract

This paper shows that standard corporate finance theory implies that there is potentially a trade off between the variances of dividends and equity prices. We show how the trade off works in a stochastic difference equation model of dividend policy demonstrating that the solution may be unstable for plausible parameter values. At the boundary of the feasible set of price and dividend variances, prices and dividends are perfectly correlated and both follow an AR(1) process. We calculate explicit formulae for the variances, and show that firms could in principle make prices completely predictable, by immediately incorporating all news about the present value of earnings into dividends. By choosing to smooth dividends firms increase the variance of prices, and may also increase the variance of dividends. We show how this can easily result in sample variances which violate variance bounds inequalities

Topics: HB Economic Theory
Publisher: Financial Markets Group, London School of Economics And Political Science
Year: 2002
OAI identifier: oai:eprints.lse.ac.uk:3492
Provided by: LSE Research Online
Download PDF:
Sorry, we are unable to provide the full text but you may find it at the following location(s):
  • http://www.lse.ac.uk/ (external link)
  • http://eprints.lse.ac.uk/3492/ (external link)
  • Suggested articles


    To submit an update or takedown request for this paper, please submit an Update/Correction/Removal Request.