Equilibrium Equity Price with Optimal Dividend Policy
26 Pages Posted: 9 Jul 2015 Last revised: 20 Jan 2017
Date Written: January 19, 2017
This paper proposes an equilibrium model for evaluating equity with optimal dividend policy in a jump-diffusion market. In this model, a representative investor having power utility over an aggregate consumption process evaluates the equity as the expected value of the discounted dividends with his stochastic discount factor, while a firm paying the dividends from its own cash reserves manages to maximize the equity price. This situation is formulated as a singular stochastic control problem of jump-diffusion processes. We solve this problem and give the equilibrium equity price and the optimal dividend policy. Numerical examples show that the aggregate consumption process and the investor's risk aversion have a significant impact on the equity price and the dividend policy. This model provides a structural explanation of equity risk premiums that is consistent with the standard theory of asset pricing.
Keywords: equilibrium equity price, optimal dividend policy, risk aversion, aggregate consumption, resumption of dividends, risk premium, jump-diffusion process
JEL Classification: G12, E43, D51
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