An Improved Model for Understanding Equity Prices
13 Pages Posted: 20 Jul 2017
Date Written: June 16, 2017
Central bank policymakers monitor equity prices, alongside a range of other asset prices, to support both their monetary and financial stability objectives.
A Dividend Discount Model (DDM) is a simple type of model that can be used to help understand past moves in equity prices. DDMs are based on the net present value relationship that relates equity prices to expected future shareholder payouts, risk-free interest rates and compensation for risk.
The Bank has recently improved its DDM. The revised model accounts for share buybacks and variation over time in long-term growth expectations. It also better captures the variation in risk-free interest rates across maturities.
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