An improved model for understanding equity prices

Quarterly Bulletin 2017 Q2 article
Published on 16 June 2017

By Will Dison and Alex Rattan

  • 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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