This preview shows pages 1–2. Sign up to view the full content.
Lecture 16
The Value of the Common Stock Market
Asset Pricing
CAPM and APT provide us with a model of expected return. The question
remains, what price should a stock sell for?
A) Dividend Discount Model
The price of a stock is equal to the infinite discounted sum of its dividends.
P = (d
1
/R
1
)+ (d
2
/R
2
)+ (d
3
/R
3
)+…+ (d
t
/R
t
)+…
Where R = (1+r) is the gross return appropriate for the stocks level of risk
d
t
is the dividend paid at time t
B) PriceEarnings Model
The price of a stock is equal to the infinite discounted sum of its earnings.
P = (E
1
/R
1
)+ (E
2
/R
2
)+ (E
3
/R
3
)+…+ (E
t
/R
t
)+…
Where R = (1+r) is the gross return appropriate for the stocks level of risk
E
t
are the earnings at time t
Stock Prices
: Given an expected stream of earnings (E
1
, E
2
, …E
t
…) and an
historical estimate of a stock’s betas, we can compute the expected return of
the stock from an asset pricing model and use this expected return to discount
future earnings.
Thus, the price of a stock depends on its risk, earnings and earnings growth
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document
This is the end of the preview. Sign up
to
access the rest of the document.
 Winter '08
 CHABOT

Click to edit the document details